When I landed a job after college, the main question in my head was how much money will I be getting in my hand at the end of the month. I am sure most of you might be having the same question. Do we just divide our Cost To Company (CTC) by 12 months? No, it’s not so convenient. But it’s neither so complex if you understand the basics of how the income tax system works in India, which I am sure you will be clear with, by the end of this article.
Understanding the Financial Year
A financial year is a 12 month period that starts on 1st April and ends on 31st March of next year. It doesn’t matter when you start your job, the financial year ends on 31st March. After the financial year ends, you start filing your tax return. The year when you file your tax return is known as Assesment year. For example – If you start your job on 1st June 2018, your financial year ends on 31st March 2019. From 1st April 2019, you start filling your return for the financial year 2018-19. And the last date to file a return will be 31st July 2019.
I know the information above must be overwhelming at this point, but please hold on. I promise you, everything will start making sense in a while.
According to the Income Tax Act, an individual’s income is bucketed into 5 sources. Your total income is the sum total of all the buckets mentioned below:
|Income from Salary||Basic Salary, HRA, Allowances, Bonus. The sum of money you receive from your employer.|
|Income from House Property (Rental)||Any income which an individual is earning as a rent.|
Income from Business or Profession
|Income from carrying a business or any other profession.|
|Income from Capital Gain||Income by selling any capital asset.|
|Income from other sources||Any income or gain which is not classified in the above four heads will fall under this category.|
The sum total of all incomes combined from above 5 heads results in Gross Income. After calculating your Gross Income, let’s try to understand various deduction benefits which government provides us by which we can save our taxes.
In order to encourage investment or savings, the government introduces multiple schemes under different sections by which taxpayers can reduce their tax liability (amount to be paid as tax) by claiming different investments/savings or expenses. It is a kind of tax benefit which helps you save tax. Let’s understand different type of deductions we can take benefit of:
1. Section 80C, 80CCC and 80CCD(1)
By investing in certain avenues you can claim the benefit of up to Rs. 1.5 lakhs under this section. Some of such investment which is eligible under these sections are
- Employee Provident Fund (12% of basic salary)
- Public Provident Fund
- ELSS (Systematic Investment Plan)
- Tax Saving Fix Deposits
- Life Insurance Premiums etc.
2. HRA Exemption
To avail HRA Exemption benefit, there are two conditions:
- An employer is paying you HRA as a component in your salary.
- An employee should be living in a rented house.
Let us see how do we calculate what amount we can deduct from our gross income towards this benefit. We need to calculate three amount and the least of these three amounts will be our HRA exemption.
- Total HRA Component received from an employer.
- 50% of Basic Salary for Metro or 40% of Basic Salary for Non-metro cities.
- Rent paid by you – 10% of Basic Salary
For example – Dheeraj’s yearly basic salary is Rs 6,00,000. His yearly house rent is Rs 1,30,000 for a flat in Bangalore (Non-metro). And his actual yearly HRA component is Rs 1,80,000. Now,
- The actual HRA received is Rs 1,80,000.
- 40% of the basic salary is Rs 2,40,000.
- Rent paid subtracts 10% of basic salary is (1,30,000-60,000) = 70,000.
- Hence, Rs 70,000 will be the tax exemption that Dheeraj can claim.
Note: If you are not getting the HRA component as part of your salary structure but if you are paying rent, then you can get a deduction up to Rs 60,000 under section 80GG.
3. Leave Travel Allowance (LTA)
It is a benefit received from an employer if you are traveling while on leave. These benefits only include the expense made on bus, rail or flight fares. Only domestic travel is considered for this benefit. You can claim LTA twice in a span of 4 years. In case you don’t use this deduction within a span, you could carry the same to the next block.
4. Standard Deduction
The Indian Government announced a standard deduction of Rs 40,000 in Union Budget 2018 replacing transport allowance and medical reimbursement. The deduction has been increased to Rs 50,000 in Interim Budget 2019.
5. Other Deductions
There are many other deductions which you can take advantage of depending upon the nature of your investment or expenses like:
- Medical Insurance Deduction (Section 80D)
- Interest on Home Loan (Section 80C and Section 24)
- Deduction for Loan for Higher Studies (Section 80E)
- Deduction for Donations (Section 80G)
- Deduction on Savings Account Interest (Section 80TTA)
- Additional Deduction for Interest on Home Loan (Section 80EE)
Learn more about deductions here.
Calculating Income Tax
Understanding Taxable Income
Now since we know how to calculate our Gross Income and we know about various deductions (benefits) which we can avail, we are at a point where we can calculate Taxable Income. So Taxable Income is Gross Income minus all deductions. Taxable Income is the amount upon which the tax will be calculated.
For example – let us consider our previous example where Dheeraj’s yearly basic salary is Rs. 6,00,000 and he gets additional HRA component of Rs. 1,80,000. So his total Gross Income is 7,80,000. Just say, he only claimed Rs. 70,000 as HRA exemption.
As we know,
Taxable Income = Gross Income – All deductions
Gross Income = 6,00,000 (Basic Salary) + 1,80,000 (HRA Allowance)
Deductions = 70,000 (HRA Exemption) + 50,000 (Standard deduction)
Taxable Income = 7,80,000 – 1,20,000
Taxable Income = Rs. 6,60,000
After calculating our Taxable Income, the next step is to calculate tax. How much percentage of our Taxable Income will we pay as a tax? For this to understand we should know about Tax Slabs.
Understanding Income Tax Slab
After you calculate your taxable income, you have to pay % of taxable income depending upon the tax slab it falls into. Let us see what is the tax slab as of 2019-20.
|Income Tax Slab||Tax Rate|
|Up to Rs. 2,50,000||Nil|
|Rs. 2,50,000 – Rs. 5,00,000||5% of total income exceeding Rs. 2,50,000|
|Rs. 5,00,000 – Rs. 10,00,000||Rs. 12,500 + 20% of total income exceeding Rs. 5,00,000|
|Above Rs. 10,00,000||Rs. 1,12,500 + 30% of total income exceeding Rs. 10,00,000|
Such tax slabs tend to undergo a change during every budget.
Note: An additional 4% Health & education cess will be applicable to the tax amount calculated as above.
Now since we have understood all the fundamentals of calculating our income tax. Let’s take up a real-life example and apply these concepts to understand it more clearly.
Ganesh is working at XYZ Co. as Software Engineer in Bangalore. His CTC is Rs. 12,00,000. Let us see his salary breakup:
|Special Allowance||Rs. 4,68,242|
|Total Gross Income||Rs. 11,34,074|
|PF (Company’s Contribution)||Rs. 55,426|
|Medical Insurance||Rs. 10,500|
|Cost To Company (CTC)||Rs. 12,00,000|
Different deductions we can consider for Ganesh are:
- Ganesh lives in 1BHK paying Rs. 8000 monthly as rent in Bangalore.
Ganesh HRA exemption would be Rs. 49,812.
- Ganesh has a monthly ELSS SIP of Rs. 5000. Yearly Rs.60,000 can be claimed under 80C.
- XYZ company deducts an additional 12% of basic salary as Employee Contribution to PF which is Rs. 55,426 which can be claimed under 80C.
- Ganesh went for a vacation to Goa, whose flight fare cost was Rs.8000 and can be claimed under LTA exemption
Now we have Gross income and all the deductions to consider for Ganesh, let us calculate tax for him.
|Gross Income||Rs. 11, 34,074|
|HRA Exemption||– Rs. 49,812|
|SIP (section 80C)||– Rs. 60,000|
|Employee PF Contributrion (section 80C)||– Rs. 55,426|
|LTA||– Rs. 8000|
|Standard Deduction||– Rs. 50,000|
|Taxable Income||Rs. 9,10,836|
|Tax Rate as per slab||Rs.12,500 + 20% of total income exceeding Rs. 5,00,000|
|Rs. 12,500 + 20% of (Rs. 9,10,836 – Rs. 5,00,000)|
|4% Cess||Rs. 3786.7|
|Total Tax Payable||Rs. 98,453.9|
So Ganesh has to pay Rs.98,453 yearly tax when his CTC is 12 lakh. So the main question is How much amount Ganesh will earn at the end of each month?
|Ganesh’s Gross Income||Rs. 94,506||Rs. 11, 34,074|
|Ganesh’s PF Contribution||-Rs. 4618||– Rs. 55,426|
|Ganesh’s Tax liability||-Rs. 8204.5||-Rs. 98,453.9|
|Ganesh’s Net Income||Rs. 81,684||Rs. 9,80,195|
Though it appears to Ganesh CTC is Rs. 12 lakhs which will make him earn Rs 1 lakh per month, we saw the final amount credited to his bank account will be Rs. 81,684 in his case. Things to note is CTC constitutes a lot of other benefits which are non-tangible income.
We covered all the basic concepts which are required to understand how income tax is calculated in India. We saw how we can apply these concepts to calculate the net tax payable step-by-step.
I tried keeping this article as simple as possible. And I hope by the end of this article everything makes sense to you as I promised you at the beginning. When I started my career, I was very confused and I wished I had such an explanation to the tax deductions which I see in my payslips. After a lot of researches and assessments, I started understanding these concepts and thought to share it with you guys. I hope this was helpful and In case you have still any queries, you can comment below or mail me at email@example.com.