How to Calculate Income Tax: A Beginner’s Guide for Salaried Employee

Have you ever had a look at your payslip and wondered where a portion of hard-earned money disappears every month? Did you just nod your head? Don’t worry, you’re not alone. For many salaried employees in India, the term ‘Income Tax’ feels confusing and intimidating.

That is the reason why salaried employees are unable to choose between both tax regimes. Regardless of your profession, it is crucial to understand the term ‘income tax’, how to calculate income tax on your savings, and which tax regime is the best for you. You must do it because it is essential to manage your personal finance smartly and maxmise your savings by reducing your taxable income.

In this blog, we’ll understand what income tax is, the jargon of salary slip, and how to calculate income tax on your salary with the help of a few examples. So, tighten up your seat belts and let’s go!

​What is Income Tax?​

Income Tax is a direct tax charged by the Central Government of India on the income earned by individuals, businesses, or any other entities. This tax is levied based on the income earned during a specific financial year, typically from sources such as salaries, wages, investments, and business profits. 

For instance, the Government will impose taxes on the incomes earned by you in the FY 2023-24.

​What is Taxable Income?​

Taxable income is the portion of your total income that is subject to taxation after taking into account the different deductions and exemptions provided by the tax laws. 

These deductions may include work-related expenses, investments in specific schemes, and contributions to particular savings instruments such as the Provident Fund or the Public Provident Fund.

​What is the Old Tax Regime and New Tax Regime?​

India’s income tax system offers two options to file taxes; the old tax regime and new tax regime.

Old Tax Regime

Old tax regime has higher interest rates, but it allows the taxpayer to claim the tax benefits on various investments and expenses. 

New Tax Regime

The new tax regime has lower interest rates compared to the old tax regime but it has limited tax exemptions and deductions.

For the fiscal year 2023-24, you can either choose the old regime or the new regime based on your gross income, exemptions, and deductions.

Note: For FY 2023-24, the new tax regime will be set as the default. 

​Step-By-Step Guide to Calculate Income Tax on Salary​

Step 1: Determine Your Gross Income

Gross income is the total income that you have earned during the financial year. Since you're a salaried employee, an income source for you is your salary. 

Income from salary equals Basic Salary + House Rent Allowance (HRA) + Leave Travel Allowance (LTA) + Transport Allowance + Any other allowance. 

Your Gross income will also include the income from other sources such as:

1. Income from house property (the rent you’re charging after renting out a property)
   
2. ​Income from capital gains (income earned by selling and purchasing of shares or any other real-estate property)
   
3. ​Income from business/profession (Income from your side business or freelancing)
   
4. ​Income from other sources (this includes interest income on savings accounts and FDs, etc.)

Example: To understand the tax calculation step-by-step, let's consider an example. Aditya is a working professional with a gross annual income of Rs. 4,80,000. He contributes Rs. 1800 to his provident fund and Rs. 200 as professional tax every month.

He owns an apartment in Gurgaon, Haryana, and does not have another source of income besides his salary. He has chosen the old tax regime for filing taxes.

Step 2: Identify Exemptions

A few components of your salary, such as HRA & LTA, are exempt from tax.You have to deduct these exemptions from your gross income to calculate income tax.

Remember, you can claim HRA only if you’re living in a rented property and paying rent to the owner. To claim HRA, you’ll have to submit rent receipts as proof. 

If you’re staying in your own accommodation or living with your parents then HRA is fully taxable.  

Example: Since Aditya is residing in his own apartment, the HRA will not be exempt.

Step 3: Calculate Tax Deductions

Tax deductions help you reduce the taxable income. Here are some deductions you can consider:

1. ​A standard deduction of Rs.50,000 is available to every salaried individual irrespective of their investments and expenditures.
2. ​You can claim up to Rs. 1,50,000 under section 80C of Income Tax Act if you invest in specific investment options such as PPF, ELSS Mutual Fund, EPF, Sukanya Smriddhi Yojana, and term-life insurance. Learn how ELSS Mutual Fund helps in tax saving.​
3. ​You can claim up to Rs. 50,000 under section 80CCD(1B) if you’re investing in NPS (National Pension Scheme).
4. You can claim up to Rs. 25,000 under section 80D if you pay a premium towards health insurance.

Some of these deductions are only applicable if you opt for the old tax regime. There are no such exemptions in the new tax regime. Moreover, there’re various other exemptions available in both regimes which you can check out separately.

Example: Since he has chosen the old tax regime and is investing in PF, he can claim up to Rs. 1,50,000 under section 80C.

Total amount Aditya can claim under section 80C: Rs. 1,800 * 12 = Rs. 21,600.

Step 4: Calculating Your Net Taxable Income

Now, you must deduct eligible expenses and investments from your gross income to arrive at your taxable income. 

Common deductions include contributions to Provident Fund (PF), investments in Equity Linked Savings Schemes (ELSS), and payments towards life insurance premiums.

Example: Taxable Income (Annually) = Gross Salary (Annually) - PF (Annually) - Professional tax (Annually)

Taxable Income = Rs. 4,80,000 - Rs. 21,600 - Rs. 2400 = Rs. 4,56,000

Step 5: Calculate Tax Liability 

As per the chosen tax regime, calculate your tax liability. 

Example: Since, Aditya has chosen the old tax regime, here’s the tax liability calculation.

Step 6: Consolidate Rebates

Tax rebate is a kind of incentive provided by the government to the individuals whose income is below a certain limit.

According to the old tax regime, you get a rebate of Rs. 12,500 under section 87A if your gross income is up to Rs. 5 lakhs. While the tax rebate in the new tax regime is Rs. 25,000 and is applicable if your gross income is up to Rs. 7 lakhs.

Example: Tax rebate = Rs. 12,500. Since the tax is less than the tax rebate, it will be compensated, and Aditya doesn’t have to pay any taxes.

Note: If your gross income is <5 lakhs under the old tax regime and <7 lakhs under the new tax regime then you don’t have to pay any taxes.

Step 7: Calculate CESS and Surcharges

Every individual whose income is taxable is liable to pay Account and Health Education CESS of 4% on the taxable income. After calculating the taxable income, add the 4% of CESS to calculate the total income tax.

If an individual’s taxable income is more than 50 lakhs and less than 1 crore, a surcharge of 10% will be applicable to them. Add the surcharge if your taxable income is more than 50 lakhs. 

Now, let’s understand how to calculate income tax on the salary with the help of a few examples. We’ll be calculating the income tax under both the regimes.

​Examples of How to Calculate Income Tax on Salary​

#1. If Annual Salary is less than 5 Lakhs

Let's consider the case of Mr. Prateek Mehra, who works at a marketing firm. He earns a salary of Rs. 5 lakhs per annum.

#2. If Annual Salary is 10 lakhs​

Let’s consider the case of Disha Sharma, who works as a software developer in an IT-firm based out of Bangalore. Disha’s annual income is 10 lakhs per annum. 

Please note that Disha is living in Bangalore in her parent’s house and hence the HRA will be taxable. For instance, let’s consider she is investing Rs. 1,200 in NPS every month.

#3. If Annual Salary is 40 lakhs

Vikas Gupta is a senior manager at a multinational corporation, earning a salary of Rs. 30 lakhs per annum. Vikas owns his apartment in Noida and hence the HRA is taxable. 

He has no additional income other than his salary. It’s important to note that he pays a monthly premium of Rs. 2,000 for the health insurance covering his family. 

Are you a freelancer and want to maximise your savings with the help of tax-saving tips? Read this article.

To wrap it up!

To calculate the income tax on your salary, it is necessary to understand your salary structure, exemptions, and deductions, determine taxable income, and then calculate the tax according to the tax rate and tax slabs. 

Calculating income tax manually can be a time-consuming task and may lead to some miscalculation. There are various free income tax calculators available in the market that you can use to calculate income tax on your salary.

There may be some exemptions and deductions you must not be aware of. Therefore, we recommend you to consult a tax-professional and understand the tax-saving schemes to reduce your tax liability.