Taxable Income refers to the amount of an individual’s or a corporation’s income that is subject to income tax by the government. It is calculated by subtracting allowable deductions, exemptions, and adjustments from gross income, which includes earnings from employment, dividends, rental income, business profits, and other sources. The exact components of taxable income can vary by country, depending on local tax laws. Determining taxable income is crucial for filing tax returns and understanding how much tax one owes. It essentially represents the base upon which tax rates are applied to compute the total tax liability.
The computation of taxable income from salary is an essential process for salaried individuals under the Income Tax Act, 1961 in India. This computation involves several steps, starting from understanding the components of salary, identifying exempt portions, and then calculating the net taxable salary.
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Understanding the Components of Salary
Salary for tax purposes includes several components:
- Basic Salary:
The core of salary packages, paid monthly.
- Allowances:
Various allowances provided by employers, such as House Rent Allowance (HRA), Dearness Allowance (DA), Leave Travel Allowance (LTA), and others.
- Bonuses:
Any bonuses received during the year.
- Commission:
This may be a fixed amount or a percentage of turnover achieved by the employee.
- Arrears of Salary:
Sometimes salary of previous years is paid in the current year; such payments are also included.
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Addition of Perquisites
Perquisites are benefits or amenities provided by an employer to employees and are taxable under specific circumstances. Examples are:
- Accommodation provided by the employer.
- Car facility.
- Stock options.
- Club membership fees.
- Insurance premiums paid by the employer.
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Inclusion of Retirement Benefits
Any contributions to retirement benefit plans such as a provident fund or gratuity that are taxable should be included. The taxation rules vary:
- Provident Fund:
Employer’s contribution exceeding 12% of salary and interest earned above 9.5% is taxable.
- Gratuity:
Exempt up to a certain limit under specified conditions.
- Pension:
Commutation of pension is partially exempt, while regular pension is taxable.
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Calculation of Gross Salary
Sum up all the components mentioned above to arrive at the gross salary. This will include basic salary, allowances, perquisites, bonuses, and any other form of remuneration received from employment.
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Deducting Allowable Exemptions and Deductions
From the gross salary, subtract the exemptions allowed under the Income Tax Act:
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House Rent Allowance (HRA):
Exempt subject to conditions related to salary, rent paid, and place of residence.
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Standard Deduction:
A flat deduction of INR 50,000 applicable to all salaried individuals.
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Leave Travel Allowance (LTA):
Exempt to the extent of actual travel costs incurred by the employee for himself/herself and family.
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Special Allowances:
Such as children education allowance, hostel allowance which are exempt up to specified limits.
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Professional Tax
Professional tax paid during the year can be deducted from the gross salary. The amount of professional tax deductible is subject to the state legislation where the employee is employed.
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Computation of Net Taxable Salary
After subtracting exemptions and professional tax from the gross salary, the amount arrived at is the net taxable salary. This is the amount on which income tax is calculated based on the income tax slabs applicable for that financial year.
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Application of Income Tax Slabs
India has progressive tax slabs, which means the tax rate increases as income increases. For the financial year 2021-2022, for instance, the tax rates for individuals below 60 years are:
- Income up to INR 2,50,000: No tax
- INR 2,50,001 to INR 5,00,000: 5% tax
- INR 5,00,001 to INR 10,00,000: 20% tax
- Above INR 10,00,000: 30% tax
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Cess and Surcharge
A health and education cess of 4% is applicable on the tax calculated. Additionally, surcharge may be applicable depending on the income level.
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Final Tax Liability
Calculate the total tax liability by adding the cess (and surcharge, if applicable) to the tax calculated as per the slabs. This gives the total tax payable by the individual.