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Calculating your income tax liability – first step to saving tax

Are you totally new to the world of income tax? Don’t know how to calculate your income tax liability, and getting confused? Ever wondered “how much income tax do I need to pay”?

Here is a step by step guide that teaches you how to calculate your income tax – while also explaining the concept of income tax slabs / brackets. There is also an illustrative example!



Each year, we have to file an income tax return that gives the particulars of our earnings and the taxes on those earnings. It also has the details of the income tax already paid by us.

(Confused about which income tax return (ITR) form to fill up? Please read “Income Tax (IT) Return Filing – Which ITR form to use?”)

But if you want to save income tax, you need to assess how much you owe the government as income tax – even before you fill the income tax return. After all, if you don’t know how much you have to pay, how can you plan to save?

So, let’s learn how to calculate your income tax liability.

Let’s keep it simple

We would take the case of a salaried person, who also has interest income – this situation is applicable to most of us, and therefore would be a good example to understand how income tax is calculated.

(Tax calculation for long term or short term capital gains is slightly different. If you are interested in knowing about it, please read “Long Term and Short Term Capital Gain – Income Tax Calculation”)

Note: Here, we are learning to calculate the overall income tax liability. We are not doing it in the format of an income tax return (ITR). If you want to know how to do that, please read “How to fill Income Tax Return Form 1 (ITR1) – Instructions and Video Tutorial” or “How to fill Income Tax Return Form 2 (ITR2) Instructions”.


Aggregating the Income

First of all, we need to add all the incomes that we have.

This would of course include your compensation or salary (including the basic, dearness allowance or DA, commission, bonus, house rent allowance or HRA, etc.). Please also add any amount paid to you annually – like a diwali bonus, or a leave travel allowance (LTA).

Add to this any interest that you have earned. This could be from your savings bank account (SBA), bank fixed deposits (FD), company FDs, or any other debt instrument.

This would give you your total income on which you need to pay tax.

Income Tax Exemptions

Certain types of income are not chargeable to tax at all. You can reduce it from your income before you calculate your tax liability.

Please note that to avail of some of the deductions, you need to meet certain conditions.

This would include things like:

The amount remaining is the amount chargeable to income tax.


Deductions from Income

Certain amounts are deductible from your taxable income if you meet certain conditions – the condition might be related to making investments in certain instruments, or making repayment of certain loans, or related to disability, etc.

The most popular deductions are available under section 80C. Here, you invest in some specified investment avenues (like PF, PPF, life insurance premiums, etc.), and you can deduct the invested amount from your taxable income.

But before that, make all the non-section 80C deductions. Please read “Reached Section 80C limit? You can still save more income tax!” to know about the applicable deductions.

Now, deduct the amount you invested in section 80C instruments. Please read “Saving Income Tax – Understanding Section 80C Deductions” to know about section 80C deductions.

The income remaining after these deductions is the income on which you have to calculate and pay income tax.

Calculating Income Tax – The concept of slabs / brackets and rates

In India, the income tax is applied in a progressive way. This means that income upto a certain limit (say, Rs. 1,50,000) is tax-free – no tax is levied if your income is below that level.

Once your income crosses this limit, a tax is levied on the remaining income in a gradually increasing magnitude. Thus, after the limit of tax free income, your income is taxed at a low rate, say 10%, upto a certain limit (say, Rs. 3,00,000).

If your income is more than that limit, then the income above that limit is taxed at a higher rate (say, 20%) upto a certain limit (say, Rs. 5,00,000).

If your income is more than this limit, then all the income above this limit is taxed at the highest rate (say, 30%).

Each of these limits or the range of incomes that have different income tax rates applicable is called an income tax slab or an income tax bracket. These slabs and the rates applicable to them can be changed every year in the budget.

(Please read “Income Tax (IT) Slabs / Brackets and rates” to know the currently applicable IT slabs)

Please note that progressively higher income tax rates are applicable only to the income above the limit of the previous level, and not on the entire income. That is, a higher income tax rate is applicable only to the income falling in that slab, and not on the entire income.

Let us understand all this using an example.

Example

Let’s say your monthly basic salary is Rs. 25,000. You get a dearness allowance (DA) of Rs. 10,000 per month, a special allowance of Rs. 2,000 per month, house rent allowance of Rs. 1,500 per month and a transport allowance of Rs. 500 per month.

You also get a yearly bonus of Rs. 25,000.

You stay in a rented place, and pay a rent of Rs. 2,000 per month. You have contributed Rs. 1,800 every month to your PF, and pay a premium of Rs. 5,000 every year for your life insurance.

You also made a donation of Rs. 5,000 to a charity.

(Assumption: You are a 35 year old male – this is important because the tax slabs are different for men and women. They are also different for senior citizens.)

Here, your total income would be:

(Rs. 25,000 + Rs. 10,000 + Rs. 2,000 + Rs. 1,500 + Rs. 500) * 12
+ Rs. 25,000
= Rs. 4,93,000.

Now, let’s subtract the exempt incomes from this.

The Rs. 500 per month transport allowance is exempt from tax in this case. The HRA would also be exempt from income tax.

Thus, income subject to tax is:

Rs. 4,93,000 – ((Rs. 500 + Rs. 1,500) * 12)
= Rs. 4,69,000.

Let’s consider the non-section 80C deductions now.

(Please read “Reached Section 80C limit? You can still save more income tax!” to know about the applicable deductions)

The donation you made to the charity would be deductible by 50%.

Thus, income subject to tax is:

Rs. 4,69,000 – (50% of Rs. 5,000)
= Rs. 4,66,500.

Now is the turn to consider Section 80C deductions.

(Please read “Saving Income Tax – Understanding Section 80C Deductions” to know about section 80C deductions)

In our example, the PF contribution and life insurance premium payment would be counted towards this.

Thus, income subject to tax is:

Rs. 4,66,500 – (Rs. 1,800 * 12) – Rs. 5,000
= Rs. 4,39,900.

This is the amount on which income tax is payable.

Let’s calculate the income tax on this amount as per the prevailing slabs for FY 2008-09 AY 2009-10.

(Confused by terms like FY and AY? Please read “Income Tax (IT) Jargon – Financial Year (FY), Assessment Year (AY) and Previous Year (PY)” to understand them better)

(Please read “Income Tax (IT) Slabs / Brackets and Rates” to know the currently applicable IT slabs)

Slab 1: Rs. 0 to Rs. 1,50,000: 0% tax

Thus, tax payable for the first Rs. 1,50,000 of your income is Rs. 0.

Slab 2: Rs. 1,50,001 to Rs. 3,00,000 : 10% tax

Tax payable for income from Rs. 1,50,001 to Rs. 3,00,000 is:

10% of (Rs. 3,00,000 – Rs. 1,50,000) = Rs. 15,000.

Slab 3: Rs. 3,00,001 to Rs. 5,00,000 : 20% tax

Tax payable for income from Rs. 3,00,001 to Rs. 4,39,900 is:

20% of (Rs. 4,39,900 – Rs. 3,00,000) = Rs. 27,980.

Thus, tax payable is:

Rs. 0 + Rs. 15,000 + Rs. 27,980
= Rs. 42,980.

An education cess of 3% would be payable on this amount.

Thus, total tax payable is:

Rs. 42,980 + 3% of Rs. 42,980
= Rs. 44,270.


A note on Tax Deducted at Source (TDS) and Advance Tax

Please note that out of the total tax payable by you, some might already have been paid by you!

This would be in the form of TDS done by your employer for your salary, or can be the TDS deducted by your bank on the FD interest that you earned during the year.

Apart from this, you might also have paid an advance tax.

Thus, the tax payable by you (if any) at the end of the year would be:

Tax amount calculated above
less any TDS
less any advance tax paid by you

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