Basics of Income Tax for Beginners

Budget 2021 update :It has been proposed to exempt the senior citizens from filing income tax returns if pension income and interest income are their only annual income source. Section 194P has been newly inserted to enforce the banks to deduct tax on senior citizens more than 75 years of age who have a pension and interest income from the bank.

1. Basics of Income Tax for Beginners

Are you just out of college and looking for a job? Or have you already landed the job and are going to file your income tax returns for the first time? If nitty-gritty of income tax and investments confuse you, ClearTax is here to help. Our aim at ClearTax is to simplify Income Taxes for you and make your financial lives easier. Basically, anybody with an income is liable to file income tax returns. Today we bring to you the basics of Income Tax you’ll need to equip yourself with and this should help you take a confident first step into your job.

2. Defining the ‘Previous year’

Previous year or the financial year or your tax year is the 12 month period that begins on 1st April and ends on the 31st March of the next year. No matter when you start your job, your tax year closes on 31st March and a new tax year starts on 1st April. So, it is important to plan your taxes for each financial year.

3. Assessment Year

It is a term you’ll often hear in relation to tax filing. It is the financial year after the previous year in which you will ‘assess’ and file your return for the previous year. So, assessment year is 2019-20 for the previous year 2018-19. Assessment year is the year in which you will file your return for the previous year. For instance, if you start your job on 1 January 2019, your tax year closes on 31 March 2019. 2018-19 is your previous year and your AY is 2019-20. The last day to file your return is 31 August 2019.  

4. Understanding your Salary

When you start your job – reach out to your payroll or HR department and get your Salary details/ Pay Slip / Tax Statement. Here, you will get an idea of the major components of your salary and how much tax will be deducted from your salary based on them.  

5. Income on which you pay Tax

Besides the salary income you receive, you may be earning an income from several other sources. Your Total Income is the sum total of all heads of income below.

Sources of Income

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Income from Salary	Salary, Allowances, Leave encashment basically all the money you receive while rendering your job as a result of your employment agreement
Income from House Property	Income from house or building, this may be owned and self-occupied or may be rented
Income from Capital Gain	Income from gain or loss when you sell a capital asset
Income from Business or Profession	Income/loss that arises as a result of carrying on a business or profession
Income from Other Sources	This is the residual head - includes your income from savings bank accounts,fixed deposits,family pension or gifts received

6. Deductions

Deductions reduce your Gross Income. These are the amounts Income Tax Department allows you to reduce your Income, bringing down your tax liability. The more you make use of the deductions allowed, the lower your tax shall be. Deductions are allowed under section 80 of the Income Tax Act (Section 80C to 80U).

7. Make Section 80C your best friend

Section 80C can take off INR 1,50,000 from your Gross Income. Given below are some of the widely-used investment vehicles under this section.

a. PPF

One of the most popular deductions under 80C is deposits to Public Provident Fund or PPF. When you open a PPF account, you need to deposit a minimum of INR 500 and a maximum of INR 1,50,000 in a year. Money deposited in a PPF account compounds, as you deposit more money in the subsequent financial years to claim deductions. PPF is a traditional and safe saving avenue to park your hard earned money. A PPF account can be easily opened with a bank.

b. Tax-saving FD

Fixed deposits assure capital protection as well as a sizable interest income for investors. To get tax benefits under 80C, you need to stay invested for at least 5 years. It is safe, but the Interest Income from it is taxable.

c. Tax-saving mutual funds or ELSS

One of the only mutual fund scheme allowed under 80C, ELSS (Equity Linked Savings Scheme) is gaining popularity among people for its historically higher performance in the recent years. Another perk of ELSS is that it has the lowest lock-in period of 3 years.

8. TDS or Tax deducted at source

TDS is Tax Deducted at Source – it means that the tax is deducted by the person making payment. The payer has to deduct an amount of tax based on the rules prescribed by the income tax department. For instance, An employer will estimate the total annual income of an employee and deduct tax on his Income if his Taxable Income exceeds INR 2,50,000. Tax is deducted based on which tax slab you belong to each year. Similarly, if you earn interest from a Fixed Deposit, the bank also deducts TDS. Since the bank does not know your tax slabs, they usually deduct TDS @ 10%, unless you haven’t mentioned your PAN (in that case a 20% TDS may be deducted).

9. Calculating Tax Payable

On your Taxable Income, tax slabs or rates are applied and final tax payable is calculated. From this tax payable, you can reduce all the TDS that has already been deducted. You can always use our Tax Calculator!

10. Standard Deduction

As per the Budget 2018, salaried employees are entitled to a standard deduction of Rs 40,000 from the gross salary. This standard deduction will replace the medical reimbursement amounting to INR 15,000 and transport allowance amounting to Rs. 19,200 in a financial year. Effectively, the taxpayer will get an additional income exemption of Rs 5,800. The limit of Rs. 40,000 has been increased to Rs. 50,000 from FY 2019-20 onwards in the Interim Budget 2019.

11. Illustration on salary TDS

Aditya is a 25-year-old software engineer living in Mumbai. He spends his free time enjoying his new found financial freedom. This is his first job and he’s clueless about tax or savings. But it’s almost the end of January and Aditya heard his friends talking about Section 80C and how they pay zero tax thanks to Section 80C. Aditya earns Rs 6,60,000 annually. Here are his salary details.

Salary components	Monthly	Annually
Basic salary	30,000	3,60,000
House Rent Allowance	15,000	1,80,000
Special Allowance	10,000	1,20,000
Total		6,60,000

Aditya looked up his pay slip and found out that his employer has been deducting a TDS on his salary of Rs 2,988 each month. This shall work out to Rs 35,860 for the whole year. While Aditya has been busy enjoying his new life he has no clue how much tax he needs to pay and whether he can save any tax! Let’s help him! Aditya should first find out his total income from all sources. Besides salary income, Aditya has earned savings bank account interest of Rs 2,500. He found this amount in his bank statement. His father had forced him to put aside Rs 50,000 in fixed deposit and from his online FD statement, he found out he will earn an interest of Rs 3,500 on this FD until 31st March 2020. Aditya is not sure whether any TDS has been deducted on his interest income – so he looks up his Form 26AS. Form 26AS has the details of all the tax deducted and deposited against Aditya’s PAN. He found TDS of Rs 2,988 deducted by his employer each month until January. Here is Aditya’s total Income:

Aditya’s Total Income
Income from salary		Rs 6,60,000
Income from other sources		Rs 6,000
Savings Bank account interest	Rs 2,500
Fixed Deposit interest	Rs 3,500
Gross Total Income		Rs 6,66,000
Tax deducted or TDS till the end of January 2020 (Rs 2,988*10)		Rs 29,880

Aditya also revealed he lives in a rented accommodation in Mumbai along with 4 other roommates and his share of rent is Rs 10,000. If Aditya can organize rent receipts from the landlord and get his PAN number, he can claim an exemption on HRA. If Aditya can submit the rent receipts well in time, to his employer – his employer will be able to adjust his tax calculations.

Aditya’s HRA exemption
HRA exemption shall be least of the following:
HRA received (A)	Rs 15,000
50% of the basic salary	Rs 15,000
Rent paid less 10% of the basic salary	Rs 7,000
HRA exempt (lower of the above) (B)	Rs 7,000
HRA taxable (A)-(B)	Rs 8,000

Now let us see Aditya’s revised tax calculation.

Tax calculation for Aditya
Income from salary		Rs 5,76,000
Basic salary	Rs 3,60,000
Taxable portion of HRA	Rs 96,000
Special allowance	Rs 1,20,000
Income from other sources		Rs 6,000
Gross total income		Rs 5,82,000
Deduction under section 80C		Rs 1,50,000
Deduction under section 80TTA		Rs 2,500
Total income		Rs 4,29,500
Tax payable		Rs 8,975
Less: Rebate under section 87A (for total income up to Rs 5 lakh)		Rs 8,975
Tax payable		Nil

Did you notice! If Aditya can manage to claim Rs 1,50,000 under section 80C – no tax shall be payable by him on account of rebate claimed under section 87A. With this deduction, his taxable income does not exceed Rs 5 lakh which is eligible for rebate under section 87A for the AY 2020-21. However, Aditya has to file an income tax return because his gross total income is above the basic exemption limit of Rs 2.5 lakh. Also, Aditya can claim a refund of the TDS of Rs 29,880 which has been deducted on his income. Aditya claims Rs 1,50,000 under section 80C. Deduction on Section 80C is available for PF @12% of Basic Salary, its Rs 43,200 for him. Since this is already deducted from salary, he simply needs to consider this amount – no additional payout is required. Aditya wants to try his hands in equities and finds the market returns promising so he invests Rs 50,000 in ELSS. He opens a PPF account and deposits Rs 57,580 – all of these add up to Rs 1,50,780. The amount of deduction eligible under section 80C is limited to Rs 1,50,000. Accordingly, Aditya claims a deduction of Rs 1,50,000 under section 80C.

Deduction under section 80C available to Aditya
EPF contribution @ 12% of basic salary	Rs 43,200
Subscription to ELSS	Rs 50,000
Contribution to PPF	Rs 57,580
Total	Rs 1,50,780
Deduction eligible	Rs 1,50,000