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What Are Income Taxes and How Do They Work?

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What Are Income Taxes and How Do They Work?

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Your income and income tax go hand-in-hand. But the emotions attached to them can vary widely. While your income makes you happy (mostly), there might be a feeling of sacrifice and stress attached to paying income tax. Also, the income tax calculation might seem complex due to slabs, exemptions, deductions and more. Let’s simplify what income tax is and understand its components in detail.

 But first, let’s try to look at income tax in a new light.

Income tax as a means to give back to your country

Income tax is a major source of revenue for the central government. It is your contribution towards nation-building. Whenever you hear about one more achievement and milestone achieved by our country like free vaccines, a new highway, metro rail or similar infrastructure projects, we feel proud as a taxpayer of our contribution towards nation building. 

Tax saving can be a common financial goal year-on-year. To save easily for this goal, you can create a Jar in the Fi money app. Jars are an effective way to save for your goals through short-term deposits. Create a Jar and name it “Tax Investment Accumulation”, or give it a name of your choice and start saving. Once your jar is full, you can use it to make a tax-saving investment of your choice. 

Let’s understand some key aspects of income tax to understand it better.

What are income tax returns?

Income Tax Return or ITR is the form to be filled by the taxpayer for calculating income tax. It is a form that includes your legal status, all your sources of income, applicable deductions and the tax payable or tax refund due to you. 

According to the income tax laws, ITR has to be filed for every financial year by an individual or business that earns income during a financial year. The income could be from salary, business profits, income from property or earned through dividends, capital gains, interests or other sources.

Tax returns must be filed by an individual or a business before a specified date. If taxpayers fail to abide by the deadline, they must pay the penalty. 

What is standard deduction in income tax?

The Income Tax Act offers a number of ways through which you can claim deductions and rebates. The deductions are allowed based on the way you spend your income.

The standard deduction is one such deduction offered to salaried individuals. Salaried individuals and pensioners may claim a certain amount under standard deduction by default without any need for investment or spending. This provision may be reviewed every year in the annual union budget. The government may provide or skip it for the financial year in the budget.

What is TDS in income tax?

TDS stands for Tax Deducted at Source. TDS is the amount of tax deducted by the employer or the deductor from your salary and other income and deposited to the Income Tax Department on your behalf. The TDS rates are set based on the age bracket and income of different individuals.

The specific amount is reduced when a certain payment like salary, commission, rent, interest, professional fees, and more are made. The person who makes the payment deducts tax at the source, while the person who receives a payment/income is liable to pay tax. It lowers tax evasion because the tax will be collected when making a payment. 

Let’s look at an example to make it easier to understand.

Let’s say a start-up pays ₹80,000 monthly rent to the owner of its office space. 

The TDS applicable on the amount is 10%, so the start-up should subtract ₹8000 and pay ₹72,000 to the owner. 

The startup should also deposit the ₹8000 deducted to the income tax department’s account, stating the owner’s Permanent Account Number or PAN. Thus, the owner will receive ₹72,000 after TDS. 

The owner can add the gross amount of ₹80,000 to their income, thereby allowing them to take credit for the ₹8,000 that the start-up has already deducted. 

Do you want to invest to save taxes? 

You can invest in Equity Linked Savings Scheme (ELSS) through the Fi Money app and save taxes up to ₹1.5 lakh. Complete your KYC registration and set your Systematic Investment Plan (SIP) date and amount. That way, you won’t need to frantically make tax-saving investments at the end of every financial year.

To sum up

Calculating, filing and paying income tax can be seen as our contribution toward building our nation rather than a necessary evil that has to be dealt with. 

As per income tax law, every individual or firm that has earned income in the financial year needs to file the ITR for that financial year. The government may choose to provide a standard deduction to be provided to all salaried professionals for a financial year. 

TDS is the amount of tax deducted by the employer or deductor from you and deposited to the Income Tax Department on your behalf.

Frequently Asked Questions (FAQs)

1. What is income tax, and how does it work?

Income tax is a direct tax levied by a government on the income of its citizens. The mandate to the central government to collect this tax is provided by the Income Tax Act, 1961. Income slabs and tax rates can be changed every year by the government in the Union Budget. 

Money earned as a salary is not the only form of income. It includes income from property, profits from business, gains from the profession (such as fees), capital gains, and income from other sources. Certain leeway is often provided by the government in the form of various deductions made from an individual's income before the tax to be levied is calculated. 

2. What is an example of income tax?

Income tax is a direct tax levied by a government on the income of its citizens. 

Let's look at an example to make it easier to understand.

Rohit has an annual income from his salary of ₹12 lakh per annum. Here are the applicable income tax rates:

3. What income taxes do we pay?

At a broad level, taxes are of the following two types:

Direct taxes

These taxes are directly paid to the concerned tax department of the government. Income tax, corporate tax, wealth tax and similar taxes are examples of direct taxes.

Indirect taxes

You do not pay these taxes to a tax department of the government directly. You pay these taxes Indirectly as they are added to the price of the goods or services you purchase from the market. Customs duty, Goods and Services Tax or GST and similar taxes are indirect taxes.

Here are the types of taxes that individuals or firms may be subject to.

Income tax is a direct tax

Two types of income taxes are:

1. Individual income tax

This is the income tax applicable to individuals.

2. Corporate income tax

This is the income tax applicable to corporations.

As an individual, resident citizen of India, you pay only one type of income tax for your income from various sources like salary, business profits, income from property or earned through dividends, capital gains, interests or other sources.

Here are the applicable tax rates for various income slabs.

Income Tax Slabs as per the old regime:

Income Tax Slabs for new regime (FY22-23) are mentioned in the table below:

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