How Is Income Tax Calculated On Salary?

Determining the income tax is the financial obligation of every earning person. In reality, it is your contribution towards the provision of public services and the overall functioning of the country to the government.

However, when it comes to calculating the income tax of employees, most of the time, it is deducted directly from their salary. It makes it essential for salaried individuals to know the computation of income tax so they can save on taxes and finalize net tax payable or refund, if any.

Thus, in this article, we will learn the steps for calculating income tax on salary.

How Is Income Tax Calculated on Salary?

1. Taxable Income is Calculated on Your Gross Salary

First, to calculate your taxable income, determine your gross salary. It is the sum of your basic salary, all allowances, bonuses and any other taxable income you receive.

Then, identify applicable exemptions and deductions like House Rent Allowance, Employee Provident Fund, etc.

After that, subtract the applicable exemptions and deductions from your gross salary to calculate your taxable income.

2. Know and Apply the Tax Slabs and Rates

Now it’s time to know the income tax slab rate for your taxable income.

However, you will get the option to choose one from the old or new tax regime. The new regime has lower slab rates than the old, whereas the old regime offers various exemptions and deductions.

So choose wisely and check for the tax slabs and apply rates applicable to your income bracket.

3. Consider Surcharge and Cess

Depending on your income level, surcharge and cess are additional charges imposed on the tax liability of individuals and entities in India.

Surcharges are imposed on individuals or entities with higher income levels. In contrast, a cess is a specific type of tax imposed for a particular purpose, such as a government cess, education cess etc.

4. Calculate Rebates and Tax Credits

Look for your eligibility for rebates and tax credits, such as the standard deduction or tax benefits for specific investments or expenses, to further reduce your tax burden.

5. Calculate Total Tax Liability

Then do a total of all the taxes calculated for each slab, considering surcharges, cess, and any applicable rebates or tax credits. It will give you your total amount of tax liability.

6. Deduct TDS or Withholding Tax

TDS stands for Tax Deducted at Source. It is based on your income and tax liability and remitted by your employer to the government on your behalf.

Thus, you can subtract TDS from your total tax liability if your employer gives your salary after this deduction.

7. Finalise Net Tax Payable or Refund

After the deduction of TDS, you will arrive at the net tax payable amount you owe, but if TDS is more than your total tax liability, you will be eligible for a refund.

On the other hand, if your tax liability is higher than the TDS, you will need to pay the remaining tax.

How To Calculate Income Tax On Salary With Example?

Gross salary: ₹10,00,000 per year.
Standard Deduction: ₹50,000
Investments: ₹1,50,000
Paid health insurance premiums (Yourself+Parents): ₹25,000 + ₹25,000 = ₹50,000

Your total income is calculated as follows:

Total taxable income = Gross Salary — Standard Deduction — Deductions

= ₹ 10,00,000 — ₹50,000 — (₹ 1,50,000 + ₹ 50,000) = ₹7,50,000

Next, you will apply the applicable tax slab rates to your taxable income of ₹ 7,50,000

Assuming the tax slab rates are as follows (old regime):

Up to ₹2,50,000: Nil tax
₹2,50,001 to ₹5,00,000: 5% tax but full rebate
₹5,00,001 to ₹7,50,000: 20% tax (₹12,500)
₹7,50,000 to ₹10,00,000: 20% tax (₹12,500)

The tax liability for your taxable income of ₹7,50,000 will be: (Nil till ₹2,50,000) + (5% till ₹5,00,000) + (20% of ₹2,50,000) = 0 + ₹12500 + ₹50,000 = ₹62,500

Add applicable surcharges or cess to the tax liability to arrive at the final tax payable.