Apr 21, 2009

How to Calculate Your Income Tax Liability

In my previous post, a brief process for calculating your taxable income or Net Income was mentioned. Continuing with the same, in this post the process to calculate your tax liability is described in detail.

How to Calculate Your Income Tax Liability
Your income tax liability depends upon your taxable income and the applicable tax slabs / tax rates.

Under Indian income tax, there are three categories of individual tax payers (Assessees) for rate purposes: Resident women, Resident senior citizen and Other individuals. For the fiscal year / financial year / previous year 2008-09 (AY 2009-10), the basic exemption limit for resident women (not being a senior citizen) is Rs. 180,000; for resident senior citizens it is Rs. 2,25,000; and for any other individuals it is Rs 1,50,000.

The income tax slab rates for the financial year 2008-09 (Assessment year 2009-10) are:
basic exemption up to Rs 3 lakh -------– 10%,
3 lakh to 5 lakh –-------------------------- 20%
5 lakh onwards --------------------------- 30%

However, certain incomes are taxable at special rates given under the Income Tax Act, 1961. In case of resident individuals following income is subject to special rates of tax:

1. Short term Capital gains (STCG) on equity shares or equity oriented mutual funds on which securities transaction tax has been paid .is taxed at the flat rate of 15 per cent under section 111A.

2. Long term capital gains(LTCG) on listed securities (shares, bonds, debentures, government securities), mutual fund units and zero coupon bonds are taxable @ 10% without indexation or 20% with indexation at your option.(Section 112).

3. All other LTCG are taxed @ 20% u/s 112.

4. Winnings from lotteries, game shows, races, card games, gambling or betting etc is taxed @ 30% u/s 115BB.

Furthermore, a surcharge of 10% is imposed if the ‘Net Income’ exceeds Rs 10 lakh. Marginal relief is provided to ensure that additional amount payable due to imposition of surcharge does not exceed the amount by which your income is more than Rs 10 lakh.

For example, in case of ‘other individuals’ the tax on Rs 10 lakh of income is Rs 2,05,000. Now if we increase the income by Rs 10,000, the basic tax becomes Rs 2,08,000 and surcharge becomes Rs 20,800 and total tax liability works out to be Rs 2,28,800. Now, due to increase of income by just Rs 10,000 tax liability increases by Rs 23,800 (i.e. Rs 2,28,800 – Rs 2,05,000). Thus, the marginal relief of Rs 13,800 (i.e., Rs 23,800 – Rs 10,000) is provided from the surcharge so that amount of surcharge gets restricted to Rs 7000 (Rs 20,800 – Rs 13,800) and final tax liability becomes Rs 2,15,000 thereby ensuring that additional tax liability doesn’t exceed additional income.

Finally, Education Cess @ 3% is levied on the amount of tax computed inclusive of surcharge (i.e., basic tax plus surcharge) and you arrive at your tax liability.

In exceptional cases, there is tax relief u/s 89 to 91 and / or interest payable u/s 234 which needs to be added / subtracted to arrive at the final tax liability.

Let’s consider an example to calculate your income tax liability. Suppose that you’re a 30 year old male resident in India and your gross total income (GTI) is, SAY, Rs 6,50,516 (inclusive of Rs 40,000 of short term capital gains from sale of shares on which STT is paid) for the financial year 2008-09 i.e., from 1st April 2008 to 31st March 2009. Further, let’s assume that you’re entitled to a deduction of Rs 80,000 under section 80C, Rs 16,000 under 80D and Rs 12,000 under 80E. So, your ‘Net Income’ or ‘Taxable Income’ becomes Rs 5,42,520 (after rounding off). Out of this Rs 40,000 will be taxed at the flat rate of 15 per cent and balance income of Rs 5,02,520 will be taxed at the normal slab rates. So your gross tax liability works out to be Rs 63,609. Further assuming tax of Rs 35,000 was deducted at source, your final tax payable is Rs 28,610.

Let’s consider another example to properly understand the process to calculate your tax liability: Supposing you’re a male individual (less than 65 years old) where your GTI is Rs 2,20,000 which includes Rs 1,70,000 of LTCG taxable @ 20%. Further, you’re entitled for a deduction of Rs 80,000 u/s 80. So, here your taxable income should be Rs 1,40,000 (Rs 2,20,000 – Rs 80,000) which is below the basic exemption limit, but actually the taxable income comes out to be Rs 20,000. Why? Because your section 80 deduction gets restricted to Rs 50,000, which is equal to your ordinary income (i.e., GTI minus income taxable at special rates). It is due to tax provisions which bar section 80 deduction from income which are taxable at concessional tax rates under the IT Act. So, accordingly in this particular example, your tax liability works out to be Rs 4,120.

I hope by now you’re able to understand how to calculate your tax liability without any professional help. However, if you’re still confused and can’t really understand this tax mumbo-jumbo; don’t worry, I’ll try to further simplify it and make it easier for you to calculate your tax liability without any outside help. Right now, I’m in the process of devising a tax calculator which will take care of all the finer points of calculating your tax liability provided you know your taxable income.

UPDATE: This post was written based on income tax rates of FY 2008-09. For the tax rates applicable during FY 2009-10 click here and for other tax changes see: Impact of Budget 2009 on Individuals.

Also see:
3. Income Tax Calculator: FY 2009-10

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