How Is Income Tax Calculated

Understanding how income tax is calculated is important for every earning individual in India, not just during tax filing season but throughout the year. Whether you are a salaried employee, a freelancer, a business owner, or a pensioner, knowing how your tax is worked out helps you plan your finances better and avoid last-minute surprises.

Income tax in India is not calculated on your total earnings alone. It depends on multiple factors such as your income sources, exemptions, deductions, tax regime chosen, and applicable tax slabs. Many people assume that tax is simply a fixed percentage of their salary, but in reality, the calculation follows a structured step-by-step process defined by the Income Tax Act.

In this guide, we explain how income tax is calculated in a clear and practical way. From identifying your total income to applying deductions, tax slabs, rebates, and cess, you will learn exactly how the final tax amount is determined. This page is designed to help you calculate your income tax correctly and make informed decisions to legally reduce your tax liability.

Who Is Liable to Pay Income Tax in India?

In India, income tax is not limited to salaried employees alone. Any person or entity that earns income above the basic exemption limit during a financial year is legally required to pay income tax, as per the Income Tax Act, 1961. The liability depends on the type of taxpayer and their residential status, not just the source of income.

Below are the main categories of taxpayers who are liable to pay income tax in India:

Individuals

Any individual earning income - whether through salary, business, profession, rent, interest, or capital gains - must pay income tax if their total income exceeds the prescribed exemption limit. This includes both resident and non-resident individuals. Age also plays a role, as senior citizens enjoy a higher basic exemption limit compared to others.

Salaried Employees

If you receive a monthly salary from an employer, income tax is usually deducted at source (TDS). However, even if TDS is already deducted, you are still liable to calculate your total income, claim deductions, and file an income tax return if your income crosses the exemption limit.

Self-Employed Individuals and Professionals

Freelancers, consultants, doctors, lawyers, and business owners are liable to pay income tax on profits earned from their business or profession. In such cases, tax is paid through advance tax instead of monthly TDS.

Hindu Undivided Family (HUF)

A Hindu Undivided Family is treated as a separate taxpayer under income tax laws. Income earned by the HUF - such as rental income, business income, or investment returns - is taxed separately from the individual members.

Companies and Businesses

Both Indian and foreign companies operating in India are required to pay income tax on profits earned during the financial year. The tax rate varies based on the type of company and applicable provisions under the law.

Partnership Firms and LLPs

Partnership firms and Limited Liability Partnerships (LLPs) are also considered separate taxable entities. They must pay income tax on their net profits, regardless of whether the income is distributed among partners.

Non-Resident Indians (NRIs)

NRIs are liable to pay income tax in India only on income that is earned or accrued in India, such as salary received for services rendered in India, rental income from Indian property, or capital gains from Indian assets.

Trusts and Other Legal Entities

Charitable trusts, associations of persons (AOPs), and bodies of individuals (BOIs) may also be liable to pay income tax depending on the nature of income and applicable exemptions.

In simple terms, any person or entity earning taxable income in India must assess their income, calculate tax liability, and comply with income tax laws, irrespective of how or where the income is earned.

Income Tax Slabs in India (Latest)

Income tax slabs in India define how much tax you pay based on your annual income. The government divides income into different ranges (called slabs), and each slab is taxed at a specific rate. As your income increases, the tax rate applicable to the higher portion of income also increases.

At present, individual taxpayers can choose between two tax regimes - the Old Tax Regime and the New Tax Regime. Both have different slab rates and rules, which directly impact your final tax liability.

Understanding the Two Tax Regimes

• Old Tax Regime: Allows multiple exemptions and deductions such as HRA, LTA, Section 80C, 80D, and others. It is suitable for taxpayers who actively invest in tax-saving instruments.
• New Tax Regime: Offers lower tax rates but removes most exemptions and deductions. It is designed for simplicity and is ideal for taxpayers who do not claim many deductions.

Latest Income Tax Slabs (Applicable for Individuals Below 60 Years)

Income Tax Slabs Under the New Tax Regime

Under the new regime, income is taxed at concessional slab rates, and no major deductions are allowed:

Income Tax Slabs for FY 2025–26 (AY 2026–27)

For the financial year 2025–26 (assessment year 2026–27), income tax is calculated based on revised slab rates. These slabs determine the tax rate applicable to different portions of your annual income.

• Up to ₹4,00,000 – No tax
• ₹4,00,001 to ₹8,00,000 – Taxed at 5%
• ₹8,00,001 to ₹12,00,000 – Taxed at 10%
• ₹12,00,001 to ₹16,00,000 – Taxed at 15%
• ₹16,00,001 to ₹20,00,000 – Taxed at 20%
• ₹20,00,001 to ₹24,00,000 – Taxed at 25%
• Above ₹24,00,000 – Taxed at 30%

Income Tax Slabs Under the Old Tax Regime

The old regime follows higher slab rates but allows deductions and exemptions:

Step-by-Step Process: How Is Income Tax Calculated?

Income tax calculation may look complicated at first, but once you break it down into clear steps, it becomes easy to understand. In India, income tax is calculated annually based on your total income, applicable deductions, and the tax regime you choose. Here’s a simple, step-by-step explanation in plain language.

Step 1: Calculate Your Gross Total Income

Start by adding up all the income you earn during a financial year. This includes income from different sources such as salary, house property, business or profession, capital gains, and other sources like interest or dividends. The total of all these incomes is called your Gross Total Income.

Step 2: Subtract Income Exemptions

Next, reduce the income that is legally exempt from tax. Common exemptions include House Rent Allowance (HRA), Leave Travel Allowance (LTA), standard deduction on salary, and certain allowances provided by your employer. After subtracting these exemptions, you get a more accurate picture of your taxable earnings.

Step 3: Claim Deductions Under Chapter VI-A

Once exemptions are deducted, you can further lower your taxable income by claiming deductions under various sections like 80C, 80D, 80E, and others. These deductions cover investments, insurance premiums, medical expenses, education loan interest, and donations. After subtracting eligible deductions, you arrive at your Total Taxable Income.

Step 4: Choose Between Old and New Tax Regime

At this stage, you need to decide whether to opt for the old tax regime or the new tax regime.

• The old tax regime allows multiple deductions and exemptions but has higher tax rates.
• The new tax regime offers lower tax rates but fewer deductions.
  Your final tax amount depends heavily on this choice.

Step 5: Apply the Applicable Income Tax Slab Rates

Now, apply the income tax slab rates based on the regime you selected. Income tax in India is calculated in slabs, meaning different portions of your income are taxed at different rates. Add the tax payable for each slab to get your total tax before cess.

Step 6: Add Health and Education Cess

After calculating the tax as per slab rates, add Health and Education Cess, which is currently charged at 4% of the total tax. If your income exceeds certain limits, surcharge may also apply.

Example: How Income Tax Is Calculated (With Calculation)

Income tax calculation for salaried individuals in India follows slab rates under two regimes for FY 2025-26 (AY 2026-27): the old regime with deductions and the new default regime without most deductions but higher slabs and rebates. Below, I'll use a realistic example of an annual salary of ₹12 lakhs (common for mid-level professionals), applying standard steps for clarity.

Example 1: Old Regime (With Deductions)

Assume Mr. Rao, a salaried resident under 60, has ₹12 lakhs gross salary. Key deductions include ₹75,000 standard deduction, ₹1.5 lakhs under Section 80C (e.g., EPF, PPF), and ₹50,000 under Section 80D (health insurance).

• Gross income: ₹12,00,000
• Less standard deduction: ₹75,000 → ₹11,25,000
• Less 80C: ₹1,50,000 → ₹9,75,000
• Less 80D: ₹50,000 → Taxable income: ₹9,25,000

Tax computation (old slabs):

Example 2: New Regime (No Deductions)

Same ₹12 lakhs gross salary for Mr. Rao. New regime skips most deductions (only standard ₹75,000 and employer NPS apply, but none here for simplicity). Taxable income: ₹12,00,000 - ₹75,000 = ₹11,25,000.

Tax computation (new slabs):

Comparison

New regime saves ₹1,17,000 here due to rebate up to ₹12L income, but old wins if deductions exceed ~₹3 lakhs. Choose annually via Form 10-IEA for old regime.

Income Tax Calculation Formula (India)

Income Tax Payable = Tax on Taxable Income + Health & Education Cess – Rebates (if any)

Step-by-Step Formula Breakdown

1. Gross Total Income (GTI)
   = Salary Income
   • House Property Income
   • Business/Professional Income
   • Capital Gains
   • Income from Other Sources
2. Taxable Income
   = Gross Total Income – Deductions (under Sections 80C to 80U)
3. Income Tax Liability
   = Tax calculated as per applicable income tax slabs
4. Final Income Tax Payable
   = Income Tax Liability
   • 4% Health & Education Cess
     – Rebate under Section 87A (if eligible)

Simple One-Line Formula

Income Tax Payable = (GTI – Deductions) × Slab Rate + 4% Cess – Rebate

EndNote

Use an Online Income Tax Calculator to Simplify the Calculation 

There are multiple online calculators to help you determine the taxable income and the tax payable. Once you input the necessary details like – your age bracket, annual salary, and the exemptions allowed like - investments made under Section 80C, 80CCD, 80D, HRA exemption (if you live in a rented property), home loan, educational loan, etc. The calculator gives you an estimate of the taxable income and the tax payable within a few minutes.

FAQs 

1. How is income tax calculated in India?

Income tax in India is calculated by adding income from all sources, subtracting eligible exemptions and deductions, and then applying income tax slab rates on the taxable income. Health and education cess is added at the end to arrive at the final tax payable.

2. Is income tax calculated on gross salary or net salary?

Income tax is calculated on taxable income, not directly on gross or net salary. Gross salary is reduced by exemptions (like HRA) and deductions (like 80C) to determine taxable income.

3. How is income tax calculated for salaried employees?

For salaried individuals, income tax is calculated after adding salary components, subtracting exemptions, claiming deductions, applying slab rates, and adding cess. TDS already deducted by the employer is adjusted against the final tax liability.

4. How is income tax calculated under the new tax regime?

Under the new tax regime, income tax is calculated by applying revised slab rates directly on income without most deductions and exemptions. This regime offers lower tax rates but limited tax-saving options.

5. How do deductions reduce income tax?

Deductions lower your taxable income. For example, if you claim deductions under Section 80C or 80D, the deducted amount is subtracted from your total income, which reduces the tax payable.