4. What are tax exemptions, deductions, and rebate

Do you have to pay tax on the entire income you receive? or can we have the option to reduce our total income so we can pay less tax? The short and simple answer is yes.

Before we go further it's better you read the previous articles to understand what I will be talking about here. You can view the playlist on "All About Tax" here.

Firstly, let's understand what is gross income and what is taxable income.

Gross income is the total income you receive from all your income sources. If you haven't read the article on the different types of income a person gets, you can read it here. This is the income you have received without paying any tax.

Taxable income as the name suggests is the income you will have after subtracting all your tax exemptions and deductions.

Tax Exemption

In simple words, tax exemption means you don't have to pay tax on certain components of your income.

For example, HRA, children's education allowances, gratuity, LTA, food coupons, relocation allowances, gifts, or vouchers, come under this category.

Through this, you can reduce your total tax liability or taxable income.

Tax Deduction

There are certain ways in which you have to do to reduce your taxable income. These are specified in section 80 of the income tax act. For example, investment in NPS, house loan interest, and health insurance premiums. By putting your money in all these specified areas, you can reduce your tax liability.

Tax Rebate

Apart from these, you will also need to understand tax rebates.

A tax rebate is a final reduction in the actual tax that you pay. it's kind of a final bargain on your taxable income. according to section 87A of the income tax act, a tax rebate is the final reduction of your taxable income. where you can reduce your tax liability by Rs:12,500.

This rebate's purpose is to reduce the taxpayer's burden, especially those who are in the lower-income slabs. If your taxable income falls below 5 Lakhs, according to section 87A, you don't have to pay tax. A rebate of 12,500 is adjusted in this scenario.

Standard Deductions

And here comes the bonus, additionally salaried people and the middle class will also get an additional standard deduction. This was presented in budget 2018 with an amount of 40,000 and the amount is revised to 50,000 in budget 2019. This means, that to the gross income you receive, you are eligible for a standard deduction of 50,000. The icing on the cake, right!

Thus, from the above, the ways to reduce tax go in this flow.

The first standard reduction of 50,000 is applied to the gross income.

Second, tax exemptions are reduced from the gross income

Third, Tax deductions are reduced from the gross income

Finally, the Tax rebate is adjusted if the gross income falls below the 5 Lakh limit.

Example 1

Let's understand this better with an example. Suppose your salaried person and your income is 8 Lakh.

You will have your standard deduction of 50,000.

Suppose your tax exemption calculated with HRA, LTA, and other allowances comes to 1.5 Lakh

Your Tax deductions calculated with investments, life insurance, NPS, etc. come to again 1.5 Lakh.

Now your total taxable income is 8 Lakhs minus 50 thousand standard deduction, minus 1.5 lakh tax exemptions, minus 1.5 lakh tax deductions, which comes to around 4.5 Lakh.

Now according to tax rebate criteria, your taxable income falls below 5 Lakh, thus you don't have to pay any taxes. But remember, you will have to file income tax returns, which is mandatory.

Example 2

Let's take another example,

Suppose you don’t have any tax deductions like investments, life insurance, or NPS to claim. Then from the above case, your gross total income of 8 Lakhs minus 50 thousand of the standard deduction and 1.5 lakh of tax exemption comes to around 6 Lakhs of taxable income. This makes your taxable income above 5 Lakh, so you will have to pay tax.