Two people in the same office earn the same salary and pay very different amounts of income tax. Neither of them has done anything exotic. One simply understands how the number that gets taxed is arrived at, and the other has never looked past the figure on his offer letter.
That gap is worth closing, because the figure on your offer letter is not the figure you are taxed on. Between the two sits a calculation, and most of what people call tax planning is just understanding that calculation.
Gross income is not taxable income
Start with everything that comes in over the year. That is your gross total income. Tax is not charged on it.
From that figure, the law allows certain amounts to be subtracted before tax is worked out. What is left is your taxable income, and that is the number the rates are applied to. The subtractions come in two broad shapes, and it helps to keep them apart.
- An exemption takes a particular kind of receipt out of the reckoning altogether. That income is simply not counted.
- A deduction counts the income, then lets you subtract a specified amount because of something you did with money — put it into a specified savings route, paid a particular kind of premium, paid interest on a particular kind of loan.
Both end at the same place: a smaller number on which tax is computed.
What a deduction is actually worth to you
This is where people overestimate. A deduction does not hand you money back. It removes a slice of income from the calculation, so what you save is that slice multiplied by the rate that would otherwise have applied to it.
Two consequences follow. The same deduction is worth more to someone taxed at a higher rate than to someone taxed at a lower one, because it is their rate doing the work. And the money you spent to get it has not come back to you — it is inside whatever you bought, often locked in for a fixed period during which you cannot withdraw it.
That second point deserves more weight than it usually gets. A deduction earned by buying something poor is not a saving. You have paid full price for the thing in order to save a fraction of its cost in tax.
How the pieces stack
The reason articles like this one used to promise dramatic results is that the subtractions stack. Amounts allowed for specified savings routes, for interest on a home loan, for a retirement contribution, for health insurance premiums, each reduce the same starting figure. Stack enough of them and taxable income falls a long way below gross income.
On top of that sits a separate mechanism people often confuse with a deduction: a rebate. A rebate is applied to the tax itself rather than to the income, and where one applies below a certain level of taxable income, the effect can be that the tax computed comes down to nothing. That is the machinery behind every headline of the "earn this much and pay no tax" kind.
Why this article no longer gives you a number
The earlier version of this post named specific limits, a specific rebate, and a specific income at which tax fell to zero. Those figures were true when they were written and are not a guide to today.
More fundamentally, India now has more than one way of computing income tax, and which one applies to you by default has changed. The whole stacking exercise above belongs to a way of computing tax in which deductions are central. Under the other, most of it does not apply at all. So a reader who assumes the old arithmetic and acts on it can end up having locked money away for years in exchange for a deduction he was never going to be able to claim.
The mechanism is durable. The numbers are not. Before you commit money to anything for tax reasons, check which method of computing tax applies to you this year and what it actually allows, using the income tax department's own material or a qualified tax professional who can look at your situation. And judge whatever you are considering as an investment first: what it holds, how long the money is locked, what it costs, and whether you would want to own it if there were no tax benefit at all.
This article is general information for education only. It is not investment advice and does not take account of your circumstances. Investments in securities are subject to market risks; please read all related documents carefully before investing.
