Finance Minister Nirmala Sitharaman in her second Budget proposed a new income tax regime wherein taxpayers have the option to remain at the current tax slabs while availing deductions or moving to a new, lower slab rate and forgoing deductions. The proposal aims to simplify taxation, but taxpayers must be wondering which regime is better for them. One thing is clear: income and taxation vary from one person to another, and every person must evaluate which option is best. Here is a simple formula to help them decide: if you can claim a deduction of 20% on your income, you are better off remaining in the old regime. Here’s how.
Take stock of all income
First, you must have an estimate for the income you hope to generate in 2020-21. There are various forms of income: salary, business income, capital gains from investments, interest from bank deposits etc. Make sure have a sense of all income you’re about to generate because this is necessary to accurately assess which regime is better for you.
Take stock of all available deductions
You can legally avoid taxes through qualified investment, insurance and expenditure. For example, PPF investments up to Rs 1.5 lakh are qualified for tax-saving investments. Life and health insurance premium also qualify for deductions. Expenses such as children’s school tuition fee, rent paid, and certain healthcare expenses all help reduce your taxable income. There’s also the standard deduction of Rs. 50,000 for salaried individuals. Ensure you are aware of all your eligible deductions.
See if you can avail 20% deductions
Now, apply our formula: do your total deductions add up to 20% of your gross income? Let’s say your income is expected to be Rs 7.5 lakh. So do your various deductions add up to Rs 1.5 lakh? If so, it’s quite likely that you have enough deductions to benefit by remaining in the old regime because your taxable income will be lower. Let’s understand this further with some calculations.
How it works
Taking the example of income of Rs. 7.5 lakh, your taxes under the old regime were Rs 65,000 assuming no deductions. In the new regime, your taxes on the same income reduce to Rs 39,000. But in the old regime, if you had claimed deductions of Rs 1.5 lakh, your taxes would be the lowest at Rs 33,800. Clearly, there are many deductions you’re eligible for even before you spend one rupee buying tax-saving investments and insurance, and you should not give them up without calculating what’s best for you.
How you could claim large deductions
Having a home loan is one of the best ways to get tax deductions. Your principal and interest payments earn deductions up to Rs 1.5 lakh and Rs 2 lakh respectively. Additionally, eligible homeowners can earn a further deduction of up to Rs 1.5 lakh on home loan interest under Section 80EEA. Theoretically, you could deduct up to Rs 5 lakh with a home loan, though around Rs 3 to 4 lakh would be a more pragmatic figure.
Where the formula doesn't work
Income tax deduction limits favour those in lower-income brackets. For those in large incomes, the formula may not help. For example, someone with a salary of Rs. 35 lakh will find it difficult to claim deductions of Rs. 7 lakh, and therefore will not achieve 20% deductions. But people whose incomes are between Rs. 5 lakh and up to around Rs. 20 lakh can claim 20% deductions through smart financial planning. Those in lower-income brackets – Rs. 12 lakh or lower – 20% deductions can be easily availed through deductions in Sections 80C and 80D alone.
The new regime promises lower taxation. However, you must check if you personally stand to benefit from it. After all, the old regime may still be the better one for the smart tax planner. When in doubt, consult a tax advisor.
Adhil Shetty is a guest contributor. Views expressed are personal.
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