Chapter 1 of 8
How Income Tax Works in India
Tax slabs, income types, and deductions foundation.
Priya landed her first job in Bengaluru with a ₹12 lakh annual package. Her first payslip arrived in April and
she noticed a chunk labelled “TDS” had already been deducted by her employer. “Why is money
missing before I even see it?” she wondered. That question is exactly where every Indian taxpayer's
journey should begin — understanding how income tax actually works.
What Is Income Tax?
Income tax is a direct tax levied by the Government of India on the income earned by individuals, Hindu Undivided
Families (HUFs), companies, and other entities during a financial year. It is governed by the
Income Tax Act, 1961 and administered by the Central Board of Direct Taxes (CBDT).
Five Heads of Income
The Income Tax Act classifies all income into five heads. Every rupee you earn falls under one of these:
Salaries — wages, allowances, perquisites from employment (most common for employees)
House Property — rental income from owned property; notional rent for vacant second homes
Business / Profession — profits from freelancing, self-employment, or running a business
Capital Gains — profit from selling assets like stocks, mutual funds, or real estate
Other Sources — interest income, dividends, lottery, gifts above ₹50,000
FY 2025-26 Tax Slabs
India uses a progressive tax system — only the income within each slab is taxed at that
slab's rate, not your entire income. From FY 2024-25 onwards the New Tax Regime is the default; you must
actively opt in to the Old Regime.
| Income Slab | Old Regime Rate | New Regime Rate |
|---|---|---|
| Up to ₹2,50,000 | Nil | — |
| Up to ₹3,00,000 | — | Nil |
| ₹2,50,001 – ₹5,00,000 | 5% | — |
| ₹3,00,001 – ₹7,00,000 | — | 5% |
| ₹5,00,001 – ₹10,00,000 | 20% | — |
| ₹7,00,001 – ₹10,00,000 | — | 10% |
| ₹10,00,001 – ₹12,00,000 | 30% | 15% |
| ₹12,00,001 – ₹15,00,000 | 30% | 20% |
| Above ₹15,00,000 | 30% | 30% |
| Standard Deduction | ₹50,000 | ₹75,000 |
| Rebate u/s 87A | Nil tax if income ≤ ₹5L | Nil tax if income ≤ ₹7L |
| Surcharge (income > ₹50L) | Applicable | Applicable |
| Health & Education Cess | 4% on tax | 4% on tax |
Since FY 2024-25, the New Tax Regime is automatically applied unless you actively opt in to the Old Regime. For salaried employees, you inform your employer at the beginning of the year; for others, you choose at the time of filing your ITR.
Step-by-Step Tax Calculation
Gross Salary: ₹12,00,000 Less: Standard Deduction (New Regime): ₹75,000 Taxable Income: ₹11,25,000
Tax Calculation (New Regime slabs):
- ₹0 – ₹3,00,000: Nil → ₹0
- ₹3,00,001 – ₹7,00,000 (₹4,00,000 @ 5%): ₹20,000
- ₹7,00,001 – ₹10,00,000 (₹3,00,000 @ 10%): ₹30,000
- ₹10,00,001 – ₹11,25,000 (₹1,25,000 @ 15%): ₹18,750
Total Tax Before Cess: ₹20,000 + ₹30,000 + ₹18,750 = ₹68,750 Add: Health & Education Cess (4%): ₹68,750 × 4% = ₹2,750 Total Tax Payable: ₹71,500 Her monthly TDS deduction = ₹71,500 ÷ 12 ≈ ₹5,958/month
TDS and Advance Tax
For salaried individuals, TDS is handled entirely by the employer. Banks deduct TDS on fixed deposit interest
exceeding ₹40,000 per year (₹50,000 for senior citizens) at 10%. Freelancers receiving professional fees above
₹30,000 have 10% TDS deducted by the client.
ITR Filing
Every individual whose income exceeds the basic exemption limit must file an Income Tax Return (ITR). The
deadline for salaried individuals with no audit requirement is July 31 of the Assessment Year.
Missing the deadline incurs a late fee of up to ₹5,000 under Section 234F.
Calculate your tax liability under both regimes at the start of each financial year. Factors like HRA, home loan interest, and Section 80C investments can tip the balance. A 15-minute comparison in April can save you thousands.
Income earned during FY 2025-26 (April 2025 – March 2026) is reported and assessed in which Assessment Year?
Key Takeaways
- India uses a progressive tax system — only income within each slab is taxed at that rate, not your entire income.
- The New Tax Regime is the default from FY 2024-25; you must opt in to the Old Regime to claim deductions like 80C and HRA.
- TDS is your employer's advance collection of your estimated annual tax — reconcile it with your actual liability when filing your ITR by July 31.
- Always distinguish between FY (when income is earned) and AY (when it is assessed) — they are different years.