Taxable Income: What it is, and How to Calculate

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If the income you earn during a financial year is above a certain limit, you must pay income tax. That said, not everything you earn is taxed. So then, how much of what you earn is actually taxable?

Here’s where the concept of taxable income comes in. Whether you’re a salaried employee, a freelancer, or a business owner, this guide can help you understand taxable income and how to calculate it.

What is Taxable Income?  

Taxable income is the portion of income you earn during a financial year on which income tax is levied. It essentially determines how much tax you pay during a year. The higher your taxable income is, the more income tax you must pay.  

Your taxable income for a financial year is calculated by taking all of the income you earned across all sources and subtracting eligible exemptions and deductions. The resulting figure is then used to calculate your final tax liability for the year. 

What are the Taxable Sources of Income? 

Under the Income Tax Act, 1961, income is classified into five distinct heads. Here’s a detailed overview of the five taxable sources of income.  

1. Salary 

The income you receive from your employer in exchange for your services is classified as salary income. Salary income includes the following components: 

• Basic pay
• Dearness allowance (DA)
• House Rent Allowance (HRA) 
• Leave Travel Allowance (LTA)
• Other allowances
• Bonuses 
• Commissions
• Perquisites 

Some allowances, like dearness allowance, are fully taxable. Meanwhile, certain allowances like HRA and LTA could be: 

• Fully exempt from tax 
• Partially taxable 
• Fully taxable

2. House Property

The income you earn by renting a house or a property is classified as house property income. To calculate the taxable house property income for a particular year, you can use the following formula.

Here, the gross annual value is taken as the higher of the following: 

• Expected annual rental income for your property 
• Municipal annual rent for your property
• Fair annual rent for your property
• Actual annual rent received for your property 

3. Profits and Gains from Business or Profession

The income you earn through your business or profession is classified under this head. The taxable component is determined by taking all of the receipts directly connected to your business or profession and subtracting allowable expenses. Some expenses that can be deducted include: 

• Rent
• Salaries
• Utilities
• Depreciation
• Marketing costs
• Other operational costs

4. Capital Gains

The profit you earn by selling an asset is classified as capital gains. The gains are classified into either long-term capital gains (LTCG) or short-term capital gains (STCG),  based on how long you held the asset before selling. 

Short-term capital gains are added to your taxable income and are taxed at the slab rate applicable to you. The only exception is STCG from equity shares and equity mutual funds. They are taxed at a flat rate of 20%. 

Long-term capital gains above ₹1.25 lakh in a financial year are taxed at a flat rate of 12.5% with no indexation benefits.

5. Other Sources

The incomes that cannot be classified under the above four heads are covered under other sources. Some of the types of income that are classified under other sources include: 

• Interest from savings bank accounts 
• Interest from recurring or fixed bank deposits
• Dividends
• Family pension 
• Lottery or game winnings
• Gifts worth more than ₹50,000 from non-relatives

Note: While most of these incomes are taxed normally, the income from lottery or game winnings is taxed at a flat rate of 30%. 

Old Income Tax Regime vs. New Income Tax Regime 

The Income Tax Act, 1961, gives you the freedom to choose between two tax systems: the old regime and the new regime.

Here’s a table outlining the differences between these two income tax regimes. 

Note: The Finance Act 2024 has made the new tax regime the default option for all taxpayers from assessment year (AY) 2024-2025 onward. This means that the new tax regime will be automatically selected when filing your income tax returns. If you wish to be taxed under the old tax regime, you can choose to opt out.

Step-By-Step Guide on How to Calculate Taxable Income

You might find the process of calculating your taxable income a little complex. To help you understand it easily, we’ve broken it down into clear, actionable steps. When you follow the steps outlined below, you can compute your taxable income quickly without any errors.   

Step 1: Identify the Heads of Income Applicable to You

The first step is to find out which of the five heads of income apply to you. For example, let’s say that you are a salaried employee with rental income and bank deposits. In this case, the following heads of income would apply to you: 

• Salary
• House Property
• Other Sources 

This step is very important because it makes sure you don’t miss reporting any source of income. 

Step 2: Calculate Income from all Heads Individually

Once you’ve identified the applicable sources of income, you must calculate the income from each head individually. When computing income, remember to account for the relevant deductions for each head. 

For calculating taxable salary income, you must deduct HRA, LTA, and standard deduction. Similarly, make sure to deduct municipal taxes, home loan interest payments, and 30% standard deduction for computing taxable house property income. 

You must exercise caution when you compute income from each head separately. This is because even a minor error at this stage could affect the accuracy of your final taxable income.

Step 3: Add the Incomes from all the Applicable Heads 

After you compute the taxable income from all applicable heads individually, you must add them together. The resulting figure is your gross total income or GTI. It represents all of the income you earned during the course of the financial year.

Step 4: Choose an Income Tax Regime 

It is important to choose the tax regime under which you want to be taxed. This is because it determines the tax deductions you can claim. 

Under the old regime, you can claim a wider range of tax deductions, including those available under Chapter VI-A of the Income Tax Act. However, the income tax rates under this regime are much higher.

On the contrary, you get to enjoy lower income tax rates under the new regime. But the list of tax deductions available to you is very limited.

Step 5: Opt for the Tax Deductions According to the Chosen Income Tax Regime

Identify and subtract all applicable tax deductions from your gross total income based on the income tax regime you’ve chosen. 

For example, let’s assume you’re a salaried individual. You’ve decided to opt for the old tax regime. You can deduct HRA, LTA, and the standard deduction of ₹50,000 from your salary income. 

However, if you had opted for the new tax regime instead, you can only subtract a standard deduction of ₹75,000 from your salary income. This is because all other deductions, like HRA and LTA, are not permitted under the new regime.        

Step 6: Compute the Taxable Income 

Once you’ve subtracted all the applicable tax deductions from your gross total income, the resulting figure is your net taxable income (NTI). This is the final amount on which your income tax liability is calculated. 

The income tax slab rates applicable to you will vary depending on the tax regime you’ve chosen. 

Lower Your Taxable Income With Smart Investments

Once you have a clear picture of what taxable income is and how to calculate it, you must shift your focus to financial decisions that reduce your income tax liability. An investment in tax-saving fixed deposits through the GoldenPi platform helps you do just that. 

GoldenPi lets you invest in tax-saving FDs from RBI-regulated banking institutions. The amount you invest qualifies for a deduction under section 80C of the Income Tax Act, 1961. This means you can reduce your taxable income by up to ₹1.5 lakh every financial year. 

Alternatively, if you’re looking for investment options that offer competitive interest rates, GoldenPi’s extensive selection of corporate bonds might interest you.          

FAQs on Taxable Income

1. What is taxable income? 

Taxable income is the total income you’ve earned during a financial year after accounting for eligible tax exemptions and deductions. The Income Tax Department (ITD) taxes you based on your taxable income.

2. What is the difference between gross income and taxable income? 

Gross income is the total income you’ve earned during a year before tax deductions. Meanwhile, taxable income is the income that remains after subtracting tax exemptions and deductions you’re eligible for as per the Income Tax Act, 1961.

3. What heads of income are included under taxable income? 

Taxable income includes income from five major heads. These are salary, house property, profits and gains from business or profession, capital gains, and other sources.

4.  How can I reduce my taxable income? 

You can reduce your taxable income by claiming deductions under Chapter VI-A of the Income Tax Act, 1961. However, deductions under Chapter VI-A are only available if you opt for the old tax regime. With the new tax regime, the number of tax deductions available is limited.

5. Are the maturity proceeds from a life insurance policy taxable?

No. Any sum of money from a life insurance policy is fully exempt from tax as per section 10(10D) of the Income Tax Act, 1961.

 

Disclaimer:

This information is for general information purposes only. GoldenPi makes no guarantee on the accuracy of the data provided here; the information displayed is subject to change and is provided on an as-is basis. Nothing contained herein is intended to or shall be deemed to be investment advice, implied or otherwise. Investments in the securities market are subject to market risks. Read all the offer-related documents carefully before investing.

The Reserve Bank of India regulates fixed Deposit schemes. GoldenPi Securities Private Limited is a registered debt broker and acts as a distributor, not as a manufacturer, of the product.