A 5 Step Guide on Income Tax
Step 1 – Heads of Income
We can classify any income that we earn, under one of five categories –
Receive a rental income from house that we own.
We may earn salary.
Enjoy capital gains(or suffer a capital loss) by selling an assest.
Get a profit(or suffer loss) from a business activity or from a professional practice.
Or an income from other source that doesn’t fall in any of the categories above.
The first step is to classify all that you earn into one or more of the above heads of income. However, not all of what you earn shall be taxed. The next step is to calculate the “Taxable” income under each head.
Step 2- Taxable Income
Under each head some part of income is excluded or not counted at all. These are called “exemption”. The benefit amount varies from person to person. We must analyse the exemptions that we specifically enjoy. Income under each head so arrived at after applying these exemptions are then summed up. Income from capital gains is calculated and taxed in a different way and therefore it is excluded from this total. The total sum of all these taxable incomes is called the “gross total income”.
Under each head of income apart from the exemptions, certain amounts are also enjoyed as Deductions. These amounts are in the nature of investments that we make, insurance premiums we pay or even the principal amounts we repay on housing loans. We may look up for section 80C to 80U to get an idea of what kind of investments or contributions we must make to avail the benefit. These amounts are deducted from gross total income and we are left with what is called the “Net Taxable Income”.
Step 4- Tax Amount
Tax amount is then calculated by applying the appropriate tax rate to the net taxable income. Education cess and additional education education cess amounts are added to this. Surcharge is also added for incomes above Rs 1 cr. Amounts for rebate and relief are then reduced.
Step 5- Refund or Tax payable
The government collects taxes beforehand in the form of TDS and advance taxes. Tax deducted at source is an amount that is deducted from our incomes directly by the person who pays us the income. Then they deposit this tax amount on our behalf, with the government. Advance tax is paid to the government by the taxpayers themselves usually every quarter.
These 5 steps ina nutshell, is nothing but all the information required for our Income Tax Return. Once we understand this structure, it is easy to see its applicability to our individual case. We may then dig deeper to understand areas where we need to exercise caution or areas where we could exploit the benefits to the maximum.