Income tax is a crucial aspect of the financial landscape for individuals and businesses alike. It is the amount of money that taxpayers are legally obligated to pay to the government based on their income. The difference between gross income and total income has significant implications for determining one’s income tax liability.
Key takeaways
- Income can be categorized into various heads, which are used to classify different types of income for the purpose of taxation.
- Your salary, dividends, capital gains, company revenue, retirement payouts, and other sources of income are all included in your gross income.
- The purpose of income classification is to determine the appropriate tax treatment for different types of income, ensuring that taxpayers pay their fair share of taxes and comply with tax laws.
Income tax calculation appears baffling to many taxpayers due to the jargon involved. But if your annual earnings fall under the taxable income slabs, you need to pay the correct tax amount to avoid penalty charges.
However, the first step to computing your payable tax is to know your gross and total taxable income. It also helps in tax planning with tax-saving instruments and claiming deductions and exemptions to reduce your tax burden. If the two terms confuse you, read on to learn about Gross total income vs total income.
What are the 5 Heads of Income?
As per the Income Tax Act (ITA), 1961, you can earn income from different sources, termed income heads. Your gross income is the aggregate of your earnings under all those heads, including
Salary
Property
Business or profession
Capital gains
Other sources
In the realm of taxation, income is a key concept that determines the amount of tax an individual or entity is liable to pay. Income can be categorized into various heads, which are used to classify different types of income for the purpose of taxation. In many countries, including the United States, India, and others, there are five commonly recognized heads of income. Let’s delve into each of these heads and gain a deeper understanding of them.
Income from Salary
Income from salary is one of the most common types of income for individuals who are employed. It includes the salary, wages, commissions, bonuses, and other monetary benefits received by an employee from their employer. It also encompasses any allowances, perquisites, or benefits in kind provided to an employee. Income from salary is usually taxed at the applicable slab rates as per the income tax laws of the country.
Income from House Property
Income from house property pertains to the rental income received by an individual for letting out a property. This can include income from residential or commercial properties, vacant land, or even letting out a part of one’s own house. The income is calculated based on the annual value of the property, which is determined by various factors such as location, size, amenities, and rental rates prevailing in the area. Income from house property is subject to taxation as per the applicable slab rates after allowing for certain deductions such as standard deduction, municipal taxes, and interest on home loans.
Income from Business or Profession
Income from business or profession covers income earned by an individual or entity engaged in any trade, business, or profession. This includes income from self-employment, freelancing, consultancy, and any other entrepreneurial activities. The income is calculated after deducting allowable business expenses such as rent, salaries, utilities, and other expenses incurred for the purpose of the business or profession. Income from business or profession is taxed at slab rates applicable to individuals or at a specific rate for entities like partnerships or proprietorships.
Income from Capital Gains
Income from capital gains is generated when an individual or entity sells or transfers a capital asset, such as stocks, real estate, or other investments, and makes a profit. The profit made on the sale of the asset is considered as capital gains and is subject to taxation. Capital gains can be classified as short-term capital gains (STCG) or long-term capital gains (LTCG) based on the holding period of the asset. Short-term capital gains are taxed at the applicable slab rates, while long-term capital gains are taxed at a lower rate or may even be exempted, depending on the nature of the asset and the holding period.
Income from Other Sources
Income from other sources is a residual category that includes any income that does not fall under the four heads mentioned above. It can include income from interest on savings accounts, fixed deposits, bonds, dividends, lottery winnings, gifts, and any other income not specifically covered under the other heads. Income from other sources is added to the total income of an individual or entity and is taxed at the applicable slab rates.
Is Classification of Income into Different Heads of Income Necessary?
Income classification is an important aspect of tax systems in many countries. It refers to the categorization of income earned by individuals or entities into different heads or categories for tax purposes. The purpose of income classification is to determine the appropriate tax treatment for different types of income, ensuring that taxpayers pay their fair share of taxes and comply with tax laws.
Tax Compliance
Classification of income into different heads of income is necessary to ensure tax compliance. Different types of income are subject to different tax rates, exemptions, and deductions. By categorizing income into different heads, tax authorities can enforce compliance by ensuring that taxpayers report their income accurately and pay the appropriate amount of taxes. This helps in preventing tax evasion and ensuring that taxpayers fulfil their tax obligations.
Fairness and Equity
Income classification promotes fairness and equity in the tax system. Different types of income have different economic characteristics and may warrant different tax treatments. For example, income from salary and wages is usually subject to tax at source, while income from investments or capital gains may be subject to different tax rates or exemptions. Income classification helps in creating a progressive tax system where taxpayers with higher incomes pay a proportionately higher amount of taxes, while taxpayers with lower incomes pay a lower amount of taxes. This ensures that the burden of taxation is distributed equitably based on taxpayers’ ability to pay.
Simplification and Clarity
Classification of income into different heads of income provides simplicity and clarity in the tax system. Tax codes can be complex, and different types of income may have different rules and regulations associated with them. By categorizing income into different heads, taxpayers can easily identify the relevant tax treatment for their income and comply with tax laws. It also makes tax administration more efficient as tax authorities can streamline their processes based on the different categories of income.
Encourages Economic Activities
Income classification can incentivize certain economic activities. Tax policies may be designed to promote specific economic activities, such as investments in certain industries or regions, research and development, or charitable donations. By categorizing income into different heads, tax authorities can provide preferential tax treatment for specific types of income, which can encourage taxpayers to engage in those activities. For example, tax incentives for investments in renewable energy may encourage taxpayers to invest in clean energy projects, leading to positive environmental and economic impacts.
International Taxation
Income classification is particularly relevant in the context of international taxation. Income earned by taxpayers in different countries may be subject to different tax laws and rates. Income classification helps in determining the appropriate tax treatment for income earned by taxpayers in different jurisdictions and avoids double taxation or tax disputes. For example, income earned by a multinational corporation in different countries may be classified as foreign-source income, and specific tax rules may apply to such income, such as foreign tax credits or tax treaties.
How to Calculate Gross Income?
For employees, calculating gross income is relatively straightforward. It typically involves adding up all forms of compensation received during a specific period, such as a year, from the employer(s) and other sources of income.
Here’s a step-by-step guide on how to calculate gross income for employees:
1. Identify Your Residential Status
Your residential status decides the earnings you are to include in your taxable income.
2. Classify Your Income
Categorize your earnings under the five income overheads:
Salary – the wages your employer pays you, including all perquisites and reimbursements (This category also covers pension income.)
House property – rental income
Business or profession - Profit from your business or earnings from your self-employment, determined by subtracting your business or professional expenses from your total receipts
Capital gains – Gains from the stock market, the sale of immovable property like land or house, movable assets such as shares, jewellery, etc.
Other sources – Any source not included in the previous four categories (Examples: royalty, lottery winnings, interest income).
3. Calculate the Amount Earned From Each Head
For this, you need to be aware of the tax-exempt income types, like agricultural income. You do not have to include those earnings in your gross income.
4. Club Your Income
You must include in your gross income some types of income your spouse or minor child earns, as per the tax laws.
5. Set Off and Carry Forward Losses
Some income heads can include various income sources. You might receive profits from one source while incurring losses from another under the same head. You can set off losses from one source against the gains from another. The tax rules also allow inter-head adjustment of such losses and profits. Moreover, you can apply previous years’ losses to the current year’s income to reduce your tax liability.
6. Compute Your Total Gross Income
The final figure from the previous steps’ calculations gives your gross income.
How to Calculate Total Income?
Section 2(45) of the ITA defines total income, and the scope is defined by Section 5.
For Indian residents: Any income received, interest accrued, and also expected to receive (deemed income)
For not ordinarily resident Indians: Income generated in foreign countries through businesses operated or controlled from India.
For non-resident Indians (NRI): Only those earnings arising or accruing in India
The Steps to Calculate Your Total Income are as follows:
1. Deduct the Following from Your Gross Income
Tax rebates, if any advance tax already paid deducted leave Travel Allowance, house rent allowance, exempt reimbursements from your employer, such as mobile bills, food coupons, etc. Interest paid on your home loan (under Section 24) Income, including
Cooperative society revenues
Royalty for specific books
Royalty on patents
Profits from infrastructure-developing enterprises
Gains from enterprises concerned with the development of defined economic zones
Deductions permitted under Section 80C through 80U
2. Round it Off
After you find your total income by claiming relevant deductions from your gross income, you have to round it off to the nearest multiple of 10.
According to Section 288A, you have to take the following factors into account:
First, ignore any paisa. If your total income amount comes to ₹5,76,897.50, you only have to take it as ₹5,76,897.
After that, if the last digit in the figure is five or more, increase the amount to the closest higher sum, which is a multiple of ten. In this case, your income became ₹5,76,897. Hence, you have to take it as ₹5,76,900.
But, if the last digit in the figure is less than 5, you have to reduce the amount to the nearest lower amount, a multiple of ten. Therefore, if your income after ignoring paisa is ₹5,76,892, you have to consider it as ₹5,76,890.
3. Apply Surcharges and Cess
Your total income is the basis for determining the tax amount you need to pay. Next, you can calculate the tax per the rate applicable to your income slab. Then, take away rebates, if any. Finally, add the applicable surcharges and Cess to get the amount you need to deposit with the tax department.
Gross Total Income vs Total Income
While they may sound similar, gross total income and total income have distinct differences in their definitions and implications. Let’s delve into and understand the difference between gross income and total income.
Parameter
|
Gross Income
|
Total/ Net Income
|
Meaning
|
An assessee’s overall income is calculated under all five income source heads as per the ITA after applying clubbing rules and setting off losses
|
The income amount is used to calculate an assessee’s payable tax amount
|
Equals to
|
The entire income earned in a financial year before claiming deductions under Chapter VI-A
|
Deductions under Section 80 (80C to 80U)
|
Tax Treatment
|
Tax is not levied on it
|
Income tax is payable on this sum
|
Deductions made under Chapter VI-A of the 1961 Income Tax Act
|
The income before deductions under Chapter-VIA of the I-T Act of 1961 is referred to as gross total income.
|
After deductions under Chapter VIA of the I-T Act of 1961, income is defined as total income.
|
Income Tax Obligation
|
Gross Total Income is not used to determine income tax obligations.
|
The total income is used to determine and/or assess the income tax obligation.
|
Gross Total Income Example
Gross total income (GTI) refers to the total income earned by an individual during a financial year before claiming any deductions, exemptions, or allowances. It includes income from all sources, such as salary, business or profession, capital gains, house property, and other sources, without any deductions. GTI serves as the starting point for calculating taxable income.
For example, let’s consider Mr. Smith, who works as a software engineer and earns a salary of ₹60,000 per year. He also has a small business on the side that generates an additional income of ₹10,000. Furthermore, he earns ₹2,000 from interest on his savings account and ₹3,000 from renting out a property. In this case, Mr. Smith’s GTI would be the sum of all these incomes: ₹60,000 + ₹10,000 + ₹2,000 + ₹3,000 = ₹75,000.
Total Income Example
Total income, on the other hand, is the income that is calculated after claiming eligible deductions, exemptions, and allowances from the GTI. It is also referred to as “taxable income”, as it is the income on which an individual’s tax liability is calculated.
For example, let’s continue with the example of Mr. Smith. Assuming he claims a deduction of ₹5,000 for investments made in a tax-saving scheme and ₹2,000 for health insurance premiums, his total income would be calculated as follows:
GTI: ₹75,000
Deductions: ₹5,000 + ₹2,000 = ₹7,000
Total Income: GTI - Deductions = ₹75,000 - ₹7,000 = ₹68,000
In this case, Mr Smith’s total income would be ₹68,000, which is the amount on which his tax liability would be calculated.
Conclusion
Although total income and gross total income sound similar, the two are not interchangeable. Income tax applies only to the latter. With careful tax planning and investments in tax savings schemes, you can reduce your total income and lower your income tax outgo.
FAQ
1
What Deductions are Available Under Section 80 of Chapter VI of the ITA?
80C: Expenses and investments up to ₹1.5 lakhs, including
- Public Provident Fund
- Employee’s Provident Fund
- National Savings Certificate
- Sukanya Samriddhi Yojana
- Atal Pension Scheme
- Equity Linked Savings Schemes
- National Pension System from the Central Government
- Tax-saving five-year term deposits from banks and post officesSpecific bonds
- Senior Citizen Savings Schemes
- Repayments made towards home loan principal amount
- Stamp duty and registration charges of property
- Children’s tuition fees
- Pension plans from life insurance companies
- Life insurance policies
80CCD: Contribution to National Pension System up to ₹50,000 over and above 80C deductions
80D: Expenses towards health insurance premiums, up to ₹25,000 if you are under 60 years of age, and up to ₹50,000 for senior citizens Interest earned on your savings account, up to ₹10,000
80E: Interest paid on education loan
80EE: Interest on a home loan, over and above Section 24 deductions, if applicable
80GG: Exemption on house rent if your salary component does not include HRA
80DDB: Medical expenses up to ₹40,000 (or ₹1,00,000 for senior citizen patients) towards specific ailments
80G: Charitable donations
80U: Deductions for taxpayers suffering from a physical disability
2
How Do You Reduce Your Total Taxable Income and Save on Tax Without Affecting Your Gross Income?
The government permits several deductions and exemptions on your gross income to reduce your taxable income. Among the deductions you can claim, the largest, up to ₹1.5 lakhs, is available under Section 80C. In addition, you can invest in various lucrative savings and investment schemes to avail of the 80C deductions and save on tax.
However, you should not select your investment tools based on tax-saving goals only. The investment avenues should also help fund your life goals. Moreover, it would help if you also planned to safeguard your financially dependent family from a shortage of funds resulting from life’s uncertainties.
Among the 80C tax-saving instruments, life insurance plans offer the unique advantage of combining life cover with savings and investment.
