How to Calculate Your Taxable Income

The income tax you’ve to pay depends on your ‘Net Income’ or ‘Taxable Income’ which is arrived at after subtracting various deductions provided under Chapter VIA (i.e., Section 80) of the Income Tax Act from the ‘Gross Total Income’ (GTI). Therefore, the first step in calculating your income tax liability is to know your Gross Total Income.

How to Calculate Your Gross Total Income (GTI)
I’ll describe in brief the various steps to calculate your Gross Total Income under IT Act:

STEP-I: First, find out the taxable income under different heads of income. There are five separate heads of income under which your total taxable income is calculated. These ‘heads of Income’ are:

1. Income from Salary
2. Income from house property
3. Income from business / Profession
4. Income from Capital Gains
5. Income from Other sources

So, you need to first compute your taxable income under each head of income separately.

STEP-2: Give effect to Set-off and carry forward of losses of current year and earlier assessment year (if any) as provided under section 70 to 74 of the Income Tax Act, 1961.

STEP-3: Total the head-wise end-results and you’ll arrive at GTI (Gross Total Income).


How to Calculate Net Income / Taxable Income
Once you know your Gross Total Income (GTI), you’ve to calculate Net Income (NI) which is also called Taxable Income. The further steps to calculate Taxable Income are:

STEP-4: Deduct various tax deductions / concessions available to you under section 80 including 80C, 80CCC, 80D, 80E, 80DD, 80E, 80G, 80GG and 80U. Check out the details at Section 80C tax-saving options and Deductions available u/s 80 other than section 80C. The resultant figure is your Taxable Income.

STEP-5: Finally, this net taxable income has to be rounded off to the nearest Rs 10 as per section 288A. Based on this ‘Taxable Income’ you can calculate your tax liability as per the rates given in relevant Finance Act.

Example:
Let’s consider an example. Suppose that during the financial year (2008-09) your total income from salary was Rs 6,30,236 (after excluding the exempted components such as medical reimbursement up to Rs 15,000, transport allowance up to Rs 800 p.m. and exempt portion of HRA) and interest income was Rs 15,000. Further let’s say you’re having a self-occupied house property and during the year you repaid a home loan installment totaling Rs 2,05,000 consisting of interest of Rs 1,40,000 and principal repayment of Rs 65,000. Your other tax savings amounted to Rs 25,500 under section 80C. Now, let’s calculate your taxable income:

Income from Salary.................................Rs 6,30,236

Income (Loss) from House Property......Rs (1,40,000)

Income from Other Sources....................Rs 15,000

Gross Total Income.................................Rs 5,05,236

Less: Deduction u/s 8OC .......................Rs 90,500

Net Income / Taxable Income.................Rs 4,14,736

Taxable Income (Rounded off)................Rs 4,14,740

Let’s consider another example to clarify the concept of set off and carry forward of losses. Suppose that in addition to the above income you’ve short term capital loss of Rs 32,000 and long term capital gains amounting to Rs 20,000. Therefore, your net loss under ‘Capital Gains’ is Rs 12,000. Now, as per section 71, losses under the head ‘Capital Gains’ can not be set off against income under any other head; however, allowed to be carried forward to the next assessment year. Therefore, your taxable income for the assessment year 2009-10 remains the same.

Now, consider another scenario (exactly reverse of the above) where you’ve STCG of Rs 20,000 and negative LTCG (i.e., loss) of Rs 32,000. Now, your income under the head Capital Gains would be Rs 20,000 and accordingly Gross Total Income and Taxable Income also increases by the same amount. Why? Because while short term capital losses can be set off against long term capital gains, reverse is not true. Put simply, long term capital losses are not allowed to be set off against short term capital gains by virtue of section 70 of the IT Act. Therefore, you’ll have to pay tax on your short term capital gains of Rs 20,000, while your long term capital loss will be carried forward to the next assessment year.

In next post I’ll describe how to calculate your tax liability.


Also see:

1. Income Tax Calculator: FY 2008-09
2. Income Tax Calculator: FY 2009-10
3. HRA Tax Calculator
4. How to Calculate Taxable HRA