How Income Tax Is Calculated in India: Complete Guide

What Is Income Tax and Why Does Calculation Matter?

Income tax is a direct tax levied by the government on income earned during a financial year (April 1 to March 31). The amount you pay depends on your total income, applicable deductions, and which tax regime you choose. India follows a progressive tax structure—higher income means higher tax rates.

Accurate tax calculation is crucial for several reasons. First, it prevents penalties—underpaying tax attracts interest at 1% per month. Second, it helps you avoid overpaying and claim deserved refunds. Third, proper calculation enables effective tax planning through strategic investments in 80C instruments, health insurance, and other deductible expenses.

Who must pay income tax? Any individual with income exceeding the basic exemption limit (₹2,50,000 for general citizens under old regime, ₹3,00,000 under new regime) must file returns and pay applicable tax. This includes salary income, business profits, rental income, capital gains, and income from other sources like interest and dividends.

The Indian tax system offers two regimes: the old regime with lower exemption limits but numerous deduction options, and the new regime with higher exemption limits but no deductions. Understanding both is essential to minimize your tax liability legally.

Income Tax Slabs for 2026: Old vs New Regime

Old Regime (with deductions): This regime allows claiming deductions under sections 80C, 80D, 80CCD(1B), HRA, and home loan interest, but has lower basic exemption limits. Tax slabs for general citizens (below 60 years):

• Up to ₹2,50,000: Nil (No tax)
• ₹2,50,001 to ₹5,00,000: 5% of amount above ₹2,50,000
• ₹5,00,001 to ₹10,00,000: ₹12,500 + 20% of amount above ₹5,00,000
• Above ₹10,00,000: ₹1,12,500 + 30% of amount above ₹10,00,000

Senior citizens (60-80 years) get higher exemption of ₹3,00,000, and super senior citizens (above 80 years) get ₹5,00,000 exemption.

New Regime (no deductions): Introduced to simplify taxation, this regime offers higher basic exemption and more tax slabs but doesn't allow most deductions. Tax slabs:

• Up to ₹3,00,000: Nil
• ₹3,00,001 to ₹6,00,000: 5% of amount above ₹3,00,000
• ₹6,00,001 to ₹9,00,000: ₹15,000 + 10% of amount above ₹6,00,000
• ₹9,00,001 to ₹12,00,000: ₹45,000 + 15% of amount above ₹9,00,000
• ₹12,00,001 to ₹15,00,000: ₹90,000 + 20% of amount above ₹12,00,000
• Above ₹15,00,000: ₹1,50,000 + 30% of amount above ₹15,00,000

Which regime is better? New regime benefits those earning below ₹12 lakh without significant deductions. Old regime is better if you have substantial investments in 80C (₹1.5 lakh), home loan interest (₹2 lakh), or NPS (₹50,000). The break-even point is typically around ₹10-12 lakh income with ₹2 lakh+ deductions—use an income tax calculator to compare both regimes for your specific situation.

Step-by-Step Income Tax Calculation Formula

Step 1: Calculate Gross Total Income – Add all income sources: salary (basic + DA + HRA + allowances), business/profession income, rental income, capital gains, interest income, and other sources. For salaried employees, your Form 16 shows this breakdown.

Step 2: Claim Deductions (Old Regime Only) – Subtract eligible deductions under Chapter VI-A: Section 80C (up to ₹1,50,000 for PPF, ELSS, life insurance, EPF contributions, home loan principal), Section 80D (up to ₹25,000-₹1,00,000 for health insurance), Section 80CCD(1B) (additional ₹50,000 for NPS), Section 24(b) (up to ₹2,00,000 home loan interest), and standard deduction of ₹50,000 for salaried employees.

Step 3: Determine Taxable Income – Taxable Income = Gross Total Income - Total Deductions. This is the amount on which tax slabs apply.

Step 4: Apply Tax Slabs – Calculate tax using the marginal rate system. Tax each income bracket separately at its rate, then sum them. For example, on ₹8,00,000 in old regime: 0% on first ₹2.5L, 5% on next ₹2.5L (₹12,500), 20% on remaining ₹3L (₹60,000) = ₹72,500.

Step 5: Add Health and Education Cess – Add 4% cess on total tax calculated. Continuing above example: ₹72,500 × 1.04 = ₹75,400.

Step 6: Apply Rebate (if eligible) – Section 87A provides ₹12,500 rebate if taxable income is below ₹5,00,000 (old regime) or ₹7,00,000 (new regime). This can reduce tax to zero within these limits.

Step 7: Subtract TDS and Advance Tax – Deduct tax already paid through TDS (shown in Form 26AS) or advance tax installments. The remaining is tax payable, or if TDS exceeds calculated tax, you get a refund.

Example: ₹8,00,000 salary under both regimes

Old Regime: Gross income ₹8,00,000. Less 80C deduction ₹1,50,000. Less standard deduction ₹50,000. Taxable income = ₹6,00,000. Tax: 0 on ₹2.5L + ₹12,500 on next ₹2.5L (5%) + ₹20,000 on remaining ₹1L (20%) = ₹32,500. Add 4% cess = ₹33,800.

New Regime: Gross income ₹8,00,000. No deductions. Taxable income = ₹8,00,000. Tax: 0 on ₹3L + ₹15,000 on next ₹3L (5%) + ₹20,000 on remaining ₹2L (10%) = ₹35,000. Add 4% cess = ₹36,400. In this case, old regime saves ₹2,600 due to deductions claimed.

Common Deductions: 80C, 80D, and More

Section 80C (up to ₹1,50,000): The most popular deduction covering PPF contributions, Employee Provident Fund (EPF) contributions, life insurance premiums, ELSS mutual funds, principal repayment on home loans, children's tuition fees, National Savings Certificate (NSC), and five-year bank fixed deposits. Maximum combined limit is ₹1.5 lakh annually.

Section 80D (up to ₹25,000-₹1,00,000): Health insurance premium deduction. You can claim up to ₹25,000 for self, spouse, and dependent children, plus additional ₹25,000 for parents (₹50,000 if parents are senior citizens). Senior citizens without insurance can claim medical expenses up to ₹50,000. Maximum total deduction is ₹1,00,000 (₹25,000 self + ₹50,000 senior citizen parents + ₹5,000 preventive health checkup).

Section 80CCD(1B) (additional ₹50,000): Exclusive deduction for National Pension System (NPS) contributions beyond 80C limit. This is over and above the ₹1.5 lakh 80C limit, allowing total pension-related deductions of ₹2 lakh.

Section 24(b) (up to ₹2,00,000): Home loan interest deduction. For self-occupied property, you can claim up to ₹2 lakh interest paid annually. For let-out property, entire interest is deductible under house property income. Note: Principal repayment goes under 80C, interest under 24(b)—these are separate deductions.

Section 80E (no limit): Education loan interest deduction with no upper limit. Covers interest on loans for higher education for self, spouse, children, or a student for whom you're legal guardian. Deduction available for 8 years or until interest is paid, whichever is earlier.

Section 80G: Donations to charitable institutions and funds. Deduction varies by institution—some allow 100% deduction, others 50%, subject to 10% of adjusted gross total income limit. Always get donation receipts with 80G registration details.

Standard Deduction (₹50,000): Available automatically to all salaried employees and pensioners. No investment or expense proof needed. This replaces the old transport allowance and medical reimbursement exemptions.

Important: All these deductions are only available in the old tax regime. The new regime doesn't allow any of these deductions except standard deduction. Choose regime carefully based on your total deductible investments.

TDS, Advance Tax, and Tax Payment Timing

TDS (Tax Deducted at Source): Employers deduct tax monthly from your salary based on projected annual income and deductions you declare. At year-end, they issue Form 16 showing total salary paid and TDS deducted. Check Form 26AS on the Income Tax portal to verify TDS credits. If TDS exceeds actual tax liability, you get a refund when filing returns.

Advance Tax: If your tax liability exceeds ₹10,000 after TDS, you must pay advance tax in quarterly installments: 15% by June 15, 45% by September 15, 75% by December 15, and 100% by March 15. This applies to freelancers, business owners, and salaried employees with significant non-salary income like rental income or capital gains.

Interest on Late Payment: Section 234B charges 1% per month interest if you don't pay at least 90% of tax liability by March 31. Section 234C charges interest on late quarterly advance tax payments. These can add significant costs, so pay on time.

Refunds: If TDS plus advance tax exceeds your actual tax liability, you receive a refund after filing returns. Refunds are processed within 4-8 weeks typically and credited directly to your bank account. Interest at 0.5% per month is paid on delayed refunds beyond the deadline.

Self-Assessment Tax: If you discover shortfall after filing returns, pay self-assessment tax before filing to avoid interest. This is common when last-minute income like bonuses or capital gains wasn't covered by TDS or advance tax.

Common Mistakes in Income Tax Calculation

Choosing wrong regime without comparison: Many taxpayers blindly choose new regime assuming it's better, or stick with old regime out of habit. Always calculate tax under both regimes considering your actual deductions. Someone with ₹8 lakh income and ₹2 lakh deductions saves significantly in old regime, while someone with ₹15 lakh income and minimal deductions benefits from new regime.

Forgetting to include all income sources: Bank interest, fixed deposit interest, rental income, freelance income, capital gains from stock/mutual fund sales—all are taxable. Forgetting these leads to incorrect calculation and potential notices from the tax department when they match against Form 26AS data.

Claiming deductions in new regime: The new regime doesn't allow 80C, 80D, HRA, or home loan interest deductions. Attempting to claim these while filing under new regime causes errors and return rejection. If you have significant deductions, old regime is likely better.

Incorrect HRA calculation: HRA exemption is the minimum of: actual HRA received, 50% of salary for metro cities (40% for non-metros), or rent paid minus 10% of salary. Many calculate incorrectly or claim full HRA without considering these limits. If you own a house in the same city, HRA is not deductible.

Not applying standard deduction: The ₹50,000 standard deduction is automatic for salaried employees but must be manually entered when calculating taxable income. Forgetting this increases tax liability by ₹5,000-₹15,000 depending on your bracket.

Missing the 4% cess: After calculating tax from slabs, you must add 4% health and education cess. This is mandatory and forgetting it understates tax by 4%. Example: ₹50,000 tax becomes ₹52,000 after cess.

Not claiming Section 87A rebate: If taxable income is below ₹5 lakh (old regime) or ₹7 lakh (new regime), you get ₹12,500 rebate that can reduce tax to zero. Many eligible taxpayers miss this, unnecessarily paying tax when they could have zero liability.

When to Use Income Tax Calculators

Regime comparison at year-start: In April when the new financial year begins, use a calculator to compare old vs new regime based on your expected salary, deductions, and investments. This helps you inform your employer which regime to use for TDS calculation, avoiding year-end surprises.

Tax planning and investment decisions: Before making 80C investments (PPF, ELSS, insurance), calculate how much tax you'll save. If you're in 30% bracket, ₹1.5 lakh investment saves ₹46,800 in tax. Use calculators to determine optimal investment amounts based on your tax bracket.

Advance tax calculation: Freelancers, business owners, and those with rental/capital gains income must pay quarterly advance tax. Calculators help estimate annual tax liability and determine correct quarterly installment amounts to avoid interest penalties.

Year-end refund estimation: Before filing returns, calculate expected refund or additional tax payable. If you're expecting a refund, file early to get money faster. If additional tax is due, plan liquidity to pay self-assessment tax.

Salary negotiation: When evaluating job offers, use calculators to determine actual in-hand salary after tax. A ₹15 lakh CTC with limited benefits may yield less take-home than ₹14 lakh CTC with tax-free benefits like LTA, food coupons, and higher EPF contribution.

Income tax calculators save time, reduce errors, and help optimize tax liability legally. They're especially useful when comparing multiple scenarios—different investment amounts, regime choices, or income variations. Link to percentage calculator for quick tax rate calculations.

Special Cases: HRA, Capital Gains, Business Income

HRA (House Rent Allowance) Exemption: HRA is partially exempt if you're paying rent. Exemption is the minimum of: (1) actual HRA received, (2) 50% of salary for metro cities (Delhi, Mumbai, Kolkata, Chennai) or 40% for other cities, (3) rent paid minus 10% of salary. Example: Salary ₹50,000/month, HRA ₹20,000, rent ₹15,000 in metro. Exemption = minimum of ₹20,000, ₹25,000 (50% of ₹50K), and ₹10,000 (₹15K - ₹5K) = ₹10,000. Taxable HRA = ₹10,000.

Short-Term Capital Gains (STCG): Gains from selling equity shares/mutual funds held less than 12 months, or property/gold held less than 24 months, are short-term. Equity STCG is taxed at 15% (plus cess) under Section 111A. Other STCG is added to your income and taxed at slab rates. Example: ₹50,000 equity STCG = ₹7,500 + cess = ₹7,800 tax.

Long-Term Capital Gains (LTCG): Equity shares/equity mutual funds held over 12 months have LTCG exempt up to ₹1 lakh, then 10% tax on excess (without indexation). Property held over 24 months has LTCG taxed at 20% with indexation benefit (adjusting purchase price for inflation). Example: ₹3 lakh equity LTCG = ₹1 lakh exempt + 10% on ₹2 lakh = ₹20,000 + cess = ₹20,800.

Business/Profession Income: If you run a business or work as a professional (doctor, lawyer, consultant), file ITR-3 or ITR-4. Maintain books of accounts showing income and expenses. You can claim business expenses—rent, salaries, utilities, depreciation—reducing taxable profit. Presumptive taxation scheme under Section 44AD allows showing 8% of turnover as income (6% for digital receipts) without maintaining books, if turnover is below ₹2 crore.

Freelance/Contract Income: Freelance income is taxed as business income. Clients deduct 10% TDS if annual payment exceeds ₹30,000. You must file returns even if income is below taxable threshold to claim TDS refund. Claim legitimate business expenses—internet, laptop depreciation, co-working space, software subscriptions—to reduce tax. Use profit margin calculator to track profitability after tax.

Filing Requirements and Deadlines

Who must file ITR: Anyone with gross total income exceeding basic exemption limit (₹2.5 lakh old regime, ₹3 lakh new regime). Also mandatory if you have foreign assets or signing authority in foreign accounts, foreign income, or want to claim a refund—even if total income is below exemption limit.

ITR Forms: ITR-1 (Sahaj) for salaried individuals with income below ₹50 lakh from salary, one house property, and other sources. ITR-2 for individuals with capital gains or multiple house properties. ITR-3 for business/profession income. ITR-4 (Sugam) for presumptive taxation under sections 44AD/44ADA/44AE. Choose correct form based on income sources.

Filing Deadlines: July 31 for individuals not requiring tax audit. Extended to September 30 or October 31 in some years (check current year notification). Late filing allowed until December 31 with penalty. If you need to file belated return after December 31, you can do so until March 31 but lose carry-forward of losses and face higher penalties.

Penalties for Late Filing: ₹5,000 if filed after July 31 but before December 31. Reduced to ₹1,000 if total income is below ₹5 lakh. No penalty if return is filed by due date even if zero tax liability. Penalty is in addition to any interest on late tax payment.

Tax Audit: Mandatory if business turnover exceeds ₹1 crore for goods trading (₹10 crore if cash receipts below 5%) or ₹50 lakh for services/profession. Requires chartered accountant audit before filing. Audit report due by September 30, ITR by October 31. Missing audit attracts heavy penalties.

E-Verification: After filing ITR, verify it within 120 days using Aadhaar OTP, net banking, or sending signed ITR-V to CPC Bangalore. Unverified returns are treated as not filed. Check ITR status on e-filing portal after verification to ensure processing.

Summary

Income tax calculation in India involves determining gross total income, applying available deductions (in old regime), calculating tax using marginal slab rates, adding 4% cess, and subtracting TDS/advance tax paid. The choice between old regime (with deductions) and new regime (without deductions but higher exemptions) significantly impacts tax liability.

Common deductions include Section 80C (₹1.5 lakh for investments), 80D (₹25,000-₹1 lakh for health insurance), 80CCD(1B) (₹50,000 for NPS), and Section 24(b) (₹2 lakh home loan interest). Standard deduction of ₹50,000 applies to all salaried employees. Calculate tax under both regimes annually to choose the beneficial option.

Salaried employees have tax deducted through TDS monthly, while others must pay advance tax quarterly. File ITR by July 31 to avoid penalties. Understanding special cases like HRA exemption, capital gains taxation, and business income rules ensures accurate calculation and compliance. Use income tax calculators for regime comparison, tax planning, and estimating refunds or liabilities.

Frequently Asked Questions