How To Calculate Income Tax – Explained with Example

Introduction

In this article, we are going to discuss 4 Steps to Calculate Income Tax for salaried individuals. If you think that calculating Income Tax is a complex thing, then you are wrong. If you are a salaried individual, then it is pretty simple and straight forward. Apart of basic maths, the only thing you need to know is about the deductions and exemptions you are claiming for and the relevant sections.

How to Calculate Income Tax?

  • Steps to Calculate Income Tax are :
    1. Computation of Gross Total Income
    2. Calculation of Tax Deductions and Net Taxable Income
    3. Determination of the Tax Liability as per Applicable Tax Slab
    4. Calculation of Tax Payable after considering TDS
Steps to Calculate Income Tax

1. Computation of Gross Total Income :

The Gross total income is the sum of all sources of income that you have earned in a financial year. Gross total income is broadly categorized in following five heads :

  1. Income from Salary
  2. Income from House property
  3. Profits and Gains from Business or Profession
  4. Income from Capital Gains
  5. Income from Other Sources
1. Income From Salary
  • As mentioned in your Form 16, Income can be charged under this head only if there is an employer-employee relationship. Gross salary includes basic salary, gratuity, advance of salary, leave encashment, all allowances, bonus etc.
  • Taxable Salary = Gross Salary – Allowances Exempt(eg. HRA, LTA etc.)
  • Example : Let’s take an example where Sunil gets Rs. 6 Lakh/year as salary (before tax) and got Rs.2 Lakh (before tax) as bonus in the year end. So Gross Salary is Rs.8 Lakh in the financial year.
  • Now, there are many allowances which gives tax exemptions, here is the list of major ones :
Major Allowances Giving Tax Exemption under Head Income from Salary
  • House Rent allowance you get on the rent you pay, it is maximum upto 50% of your salary. More details in our HRA video.
  • So for our example, let’s assume Sunil lives in a rented apartment in Mumbai and pays Rs.10,000/month as rent and gets HRA benefit on full amount.
  • Apart from HRA exemption, he also gets a standard deduction of Rs.40,000 (from FY2019-20, proposed limit is Rs.50,000) For claiming Standard deduction, you do not need to submit any proof and can directly deduct Rs.40,000 from your gross salary.

So this is how we can calculate his salary taxable under the head Income from Salary. Remember all these details would be part of Sunil’s Form 16 as well :

Form 16 Details
2. Income From House Property
  • Income from house property constitutes the income earned from a property by its owner. Property hereby refers to any residential or commercial building or land attached.
  • This head of income taxes notional income too. The taxability may not necessarily be of actual rent or income received but the potential income, which the property is capable of yielding (For FY2019-20, it is proposed in the Interim budget that, If a taxpayer has two house properties and other property is vacant, then the second property will also be exempt from tax.)
  • Let’s understand here with one simpler scenario.
  • If Sunil has one property in his name but he is living in different location and this property is earning him a rent of Rs.20,000/month.
  • we also assume that Sunil has taken loan for his property and is paying annual interest of Rs.1,00,000 on it and is paying Rs.10,000/year as Municipal Tax.
  • In that case, Following will be the Income of House property :
Income of House Property
  • Now, There are 2 deductions available under Section 24 :
    1. Standard Deduction – Standard Deduction is 30% of the Net Annual Rent Value calculated above. This deduction is irrespective of the actual expenditure you may have incurred on insurance, repairs, electricity, water supply etc. So in our example, Standard deduction is 30% of Rs.2,30,000 which is Rs.69,000.
    2. Deduction of Interest on Home Loan – In case you take a home loan for purchase, construction, repair, renewal or reconstruction of your house property – the interest is allowed as a deduction from the Net Annual Value. In case of let out house property, the loss on house property cannot exceed Rs. 2,00,000. If it exceeds, then the exceeding amount can be carried forward up to 8 assessment years.
3. Profits & Gains from Business or Profession
  • Income earned through your profession or business is charged under the head profits and gains from business or profession. The income chargeable is the difference between the revenue from business operations and business expenses incurred.
  • The deductions allowed are depreciation of assets used for business; rent for premises; insurance and repairs for machinery and furniture; advertisements; travelling and many more. Here we are assuming Sunil doesn’t have any income under this head.
4. Income From Capital Gains
  • Any gain/loss arising from transfer of capital asset held as investments is taxable under the head capital gains. Gains can be on short-term or long-term gains.
  • A capital gain arises only when a capital asset is transferred. For example, selling a property, or a Stock or a Mutual Fund unit etc.
  • For the sake of simplicity, we are considering that Sunil doesn’t have any income from Capital Gains.
5. Income From Other Sources
  • Any income that does not fall under any of the above four heads of income is taxed under the head income from other sources.
  • An example is interest income from bank deposits, winning from lottery, any sum of money exceeding Rs.50,000 received from a person as a gift. We are assuming no such income of Sunil.

So, Gross Total Income is (Income From Salary + Income From House Property) = (Rs. 6,37,500 + Rs.61,000 = Rs.6,98,500).

Let us discuss the further steps to calculate income tax.

2. Calculation of Tax Deductions and Net Taxable Income

Now after knowing your gross total income, Next step is to calculate Tax Deduction which is a way to reduce the taxable income and therefore the tax. One can claim the deduction in different ways. Popular tax saving options are :

Tax Deductions
Deduction Details
  • Now for Sunil’s example, let’s assume, Sunil has invested Rs.50,000 in Employee provident fund, Rs.50,000 in Tax Saving Mutual Funds also called as ELSS and Rs.50,000 he has paid back his home loan principal payment in the financial year under consideration.
  • Let’s also assume he has taken Health insurance which has premium of Rs.20,000/year. He has not used any other tax deduction. So he has appreciatively utilized his max limit of Section 80c i.e. Rs 1.5 lacs + deduction under section 80D.
  • So total deduction for Sunil is Rs 1.7 lacs which is reduced from his gross total income and therefore his net taxable income is Rs.5,28,500.

3. Determination of the Tax Liability as per Applicable Tax Slab

Next step is to determine the tax payable as per applicable Tax Slab. For FY 2018-19 applicable Tax slab rates are given below.

Tax Slab
  • Now, assuming Sunil to be a taxpayer below 60 years and his taxable income is Rs.5,28,500, so he falls under 20% tax bracket and his income tax will be calculated as below :
  • He will not pay any tax on first Rs.2.5 lakhs of his income, for rest Rs.2.5 lakh, he will pay 5% of tax and for the amount above Rs.5 lakhs, he will pay 20% of tax. After adding education cess, the total income tax will be :
Tax Calculations

So Rs.18,928 is Sunil’s total Tax liability for the year.

4. Calculation of Tax Payable after considering TDS

  • Now next step is to know how much TDS you have paid and determining self-assessment tax to be paid. TDS amount deducted can be checked in your Form 16 and Form 26AS.
  • If total TDS paid is more than your tax liability, then you can apply for tax refund during return filing.
  • If TDS is less than tax liability, then the difference need to be paid while filing the returns. This differential liability is known as “Self-assessment tax”.
  • In this example, let us assume Sunil has TDS on salary of Rs.15,000. Now, Sunil should pay Self-assessment tax of Rs.3,928 (Rs.18,928 – Rs.15,000).