Understanding the five heads that are used to compute income tax

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Under Section 14 of the Income Tax Act of 1961, individuals are allowed to have multiple sources of income. For such a person’s income, the computation of income tax is a crucial aspect that cannot be missed out. As simple as it sounds, to avoid any confusion, the revenue must be accurately categorised for a proper understanding as there are a variety of ways a person can earn money through investment returns, rental income, company income, and capital gains.

Section 14 of the Income Tax Act of 1961 categorises five heads of income to ensure that these various revenues are covered and taxed accordingly. Further, the government has bifurcated different types of income under different headings to calculate the income tax appropriately.

Let’s take a look at these five heads that are provided under the Income Tax Act:

Income from salary

Your salary falls under this category in case if you are a salaried employee. Your company will deduct TDS and remit it to the government in accordance with your tax bracket. This simply assimilates any compensation received by an employee in exchange for services rendered under an employment contract.

However, this happens only if there is an employer-employee relationship between the payer and the payee so that this sum can be quality for income tax consideration.  Under this heading, the gross pay is taxed after the total amount of income is computed. Further TDS will be deducted from pensions, gratuities, pensions, annuities, fees, leave encashment, and the profits that you get from your employer in addition to your base pay.

Under the income tax legislation, the term salary is defined as wages, advances, allowances, pension, gratuity, and retirement benefits.

Income from house property

Under the second category, the income tax from how property is computed. As per the Income Tax Act, 1961, sections 22 to 27 include procedures that calculate the person’s total standard income from the house property or land that individual possesses.

One important point is that the tax is based on the land or property and not on the amount of rent you earn from it unless it is rented to a business. The rental income from the properties is included in this category.

That said, the property in which you currently reside, and you are not earning any rental income provides you tax benefits. This benefit is realised through interest deductions on home loans. Rent income will be considered if the property is rented out in the ordinary course of business.

Income from profits of business

The income that you earned from the profits of a business or a profession comes under the computation of total income as the income from the profits of the business. Here the difference between the revenue collected and the expenses will be charged. That said, the income earned from the business, trade, or any profession is taxed under this category. To calculate your profits, subtract your expenses from your revenues and then apply the income tax under this category.

Capital gains

Capital gains are profits or gains earned by an assessee on the sale or transfer of a capital asset held as an investment. Capital gains are defined as any property that an assessee owns to conduct business or practice a profession.

In simple words, capital gains are gains or earnings realised through the transfer or sale of capital assets previously held as investments. This category encompasses investments in stocks, mutual funds, real estate, and a range of other assets.

Capital gains tax is determined depending on the duration of ownership of the capital asset. The two types of capital gains are long-term capital gains (LTCG) and short-term capital gains (STCG).

Income from other sources

Other sources of income are the final of the five income tax categories. This revenue category includes all other types of income. This includes winnings from horse racing or the lottery, gifts, dividend income, and interest on government bonds and stocks.