Basics of Income Tax for Beginners

Filing tax returns annually is mandatory, and knowing the basics of income tax helps individuals meet obligations and optimize tax savings through deductions and exemptions. Be it salaried, a business owner, or a freelancer, understanding these fundamentals ensures proper tax planning.

Income Tax for Beginners

The basics of income tax revolve around generating revenue for the government. The funds collected play a vital role in financing essential public services, infrastructure projects, and welfare programs that contribute to societal well-being and economic growth. By understanding income tax in India, individuals can better appreciate its significance and ensure compliance while exploring ways to minimize their tax burden legally.

Basic of Income Tax Knowledge

To grasp the taxation system effectively, individuals must be familiar with key concepts within the basics of income tax. These fundamental terms define how tax is calculated, who is liable, and the periods involved in tax assessment.

Financial Year

The Financial Year (FY), also known as the Previous Year, spans 12 months from April to March, during which an individual or business earns income. It is the period for which income is calculated and later assessed for tax purposes.

Assessment Year

The Assessment Year (AY) follows the Financial Year, which is when taxpayers file returns for the income earned in the previous year. For instance, for income earned in the Financial Year 2024-25, the Assessment Year would be 2025-26.

Person

Defined u/s 2(31) of the Income Tax Act, 1961, a ‘person’ includes an Individual, Hindu Undivided Family (HUF), Firm, Company, Association of Persons (AOP), Body of Individuals (BOI), Local Authority, and Artificial Juridical Person.

Assessee

An assessee is any person who is liable to pay income tax under the Act. This includes individuals, companies, and other entities with taxable income.

Income

As defined u/s 2(24) of the Income Tax Act, income refers to earnings from various sources, including salaries, business profits, property rent, capital gains, and other investments. For businesses, income signifies the revenue generated through operational activities.

Previous Year

The Previous Year is the financial year in which income is earned. As per Section 3 of the Income Tax Act, taxes are paid in the Assessment Year for the Previous Year’s income. For example, income earned in FY 2023-24 will be taxed in AY 2024-25.

Income tax is categorized into five primary heads, each representing a different source of earnings:

• Salary Income: Includes wages, bonuses, pensions, and allowances received from employment.
• Income from House Property: Earnings derived from renting out residential or commercial property.
• Profits and Gains from Business or Profession: Revenue generated from business operations or professional services.
• Capital Gains: Profits from selling capital assets like real estate, stocks, or mutual funds.
• Income from Other Sources: Miscellaneous earnings such as interest, dividends, lottery winnings, and gifts exceeding the exempted limit.

Concepts of Income

The basics of income tax include two key concepts related to income: Application of Income and Diversion of Income. These concepts determine whether an income is taxable or exempt under the law.

Application of Income

Application of income occurs when income is first earned by an individual or entity and then allocated to a specific purpose. Since the income is received before being spent, it remains taxable under the basics of income tax framework.

Example:

Mr. Ramesh, a salaried employee, decides to donate 15% of his annual earnings to a charitable organization. In this case, the income is first received by Mr. Ramesh and then allocated to charity. Therefore, it qualifies as an application of income and remains taxable.

Diversion of Income

Diversion of income happens when income is transferred to another party before it reaches the taxpayer. Since the income never legally belongs to the assessee, it is not considered taxable under the basics of income tax.

Example:

A court orders that 30% of Mr. Sharma’s rental income be directly paid to his ex-spouse as part of a legal settlement. Since Mr. Sharma never receives this portion of the income and is instead diverted before it reaches him, it qualifies as a diversion of income and is not taxable in his hands.

Income on Which Tax Needs to be Paid

Along with salary earnings, individuals are liable to pay taxes on other sources of income as well. The basics of income tax define five main categories of taxable income:

Income from Salary

This category applies to individuals who receive a fixed salary from an employer. The employer-employee relationship must be established for income to fall under this category. Compensation includes wages, bonuses, commissions, and other employment-related earnings.

Income from House Property

This refers to earnings from renting out residential or commercial property. The tax on such income is calculated based on the annual value, which is determined through various valuation methods:

• Fair Value – Expected rental value based on the area.
• Market Value – The standard rate set by builders.
• Standard Value – Value fixed by local authorities.
• Actual Rent Received – The real rental income earned.

To calculate taxable income, the following deductions are applied:

• Unrealized rent (income not received)
• Municipal tax paid
• 30% standard deduction (as per Section 24 of the Income Tax Act)
• Interest on home loan (if applicable)

Income from Capital Gains

Any profit earned from the sale of capital assets, like real estate, stocks, or mutual funds, falls under this category. Capital gains can be classified into:

• Short-term capital gains (STCG) – Gains from assets held for a short period, usually less than 36 months.
• Long-term capital gains (LTCG) – Gains from assets held beyond the short-term period, often taxed at different rates.

Income from Business or Profession

Profits generated from running a business or practicing a profession (such as freelancing, consultancy, or self-employment) fall under this head. Business owners and professionals must report income after deducting business expenses.

Income from Other Sources

Any earnings that do not fall under the above categories are taxed under this head. Common examples include:

• Interest from savings accounts, fixed deposits, or bonds
• Dividends from investments
• Lottery winnings or gambling income
• Gifts received beyond the exemption limit

Tax Deductions & Tax Exemptions

Tax deductions and tax exemptions are provisions that allow taxpayers to lower their taxable income, ultimately lowering the amount of tax payable. Knowing the difference between the two ensures that taxpayers can maximize their savings while staying compliant with tax laws.

Tax Deductions

Tax deductions are benefits provided under the basics of taxation in India that help individuals and businesses lower their taxable income, thereby reducing their overall tax liability. The Income Tax Department permits deductions for specific expenses and investments under Section 80 (ranging from Section 80C to 80U) of the Income Tax Act. Here is a simple formula to understand how deductions work:

The higher your deductions, the lower your taxable income, which ultimately reduces the tax you owe.

Tax Exemptions

Tax exemptions exclude certain types of income from taxable earnings, providing additional relief to taxpayers. These exemptions can lower the amount of income subject to taxation, thereby minimizing the overall tax burden.

For example, if you are a salaried individual and obtain a House Rent Allowance (HRA) as a portion of your salary, a specific portion of this allowance may be exempted from tax, depending on your salary structure and rent payments. This means that only the taxable portion of your HRA is included in your gross income for tax calculations.

Categories of Taxpayers

Learning the classification of taxpayers is essential in determining tax liabilities, exemptions, and benefits under the basics of taxation framework. The Income Tax Act categorizes taxpayers into different groups based on residency and age:

• Residents and Non-Residents (Below 60 years of age): Individuals who either qualify as Indian residents or non-residents under the tax laws. Their tax obligations vary based on their residential status.
• Senior Citizens (60–80 years): Special tax benefits are provided to senior citizens, including higher exemption limits and relaxed filing procedures.
• Resident Super Senior Citizens (80+ years): Super senior citizens enjoy further tax benefits, including a higher exemption threshold compared to other taxpayers.

Tax Deducted at Source (TDS)

Tax Deducted at Source (TDS) is a key mechanism within the basics of income tax, ensuring timely tax collection. Under this system, a specified percentage of tax is deducted at the source of income before it is credited to the recipient.

The employer deducts TDS from an employee’s salary based on the determined tax liability for the financial year. The deducted amount is then deposited with the Income Tax Department on behalf of the employee.

Similarly, banks deduct TDS on interest earned from fixed deposits, typically at a rate of 10%. However, if the depositor has not provided their Permanent Account Number (PAN), the deduction rate may increase to 20%. In cases where the depositor submits Form 15H or 15G (as applicable), banks may waive TDS deductions.

TDS applies to multiple sources of income, such as salary, rent, professional fees, and dividends.

Documents for Filing ITR

The income tax basics allow an individual to learn about the process of filing an ITR. An assessee should produce the following documents to file an ITR:

• The individual should have their PAN and Aadhaar cards.
• If the assessee wishes to claim a rebate on the taxable income, they must produce the loan documents.
• The assessee must maintain the financial year’s balance sheet to show the business’s liability, assets, income, and expenditures.
• They must produce the audit record, if applicable.
• They must show the certificate of tax deduction, such as TDS.
• They must produce the challan copy of the tax paid in advance.

Standard Deduction

As per the new budget, the government has continued to provide a standard deduction to salaried individuals and pensioners, allowing a fixed deduction from their total income before tax is calculated. In FY 2025–26, the standard deduction remains ₹75,000 (₹50,000 under the old regime) for both salaried employees and pensioners. This deduction is granted regardless of actual expenses incurred, ensuring tax relief for individuals in these categories.

Wrapping Up

Understanding the basics of income tax is an essential step toward financial literacy. As a beginner, taking the time to comprehend these fundamental concepts will enable you to successfully navigate the tax system confidently and ensure compliance with regulatory requirements. Remember, knowledge is key to making informed financial decisions and securing your financial well-being.