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Are the new tax slabs right for you?

The good thing is that the Government has left the decision of which method to pick for tax calculation, to you. You decide whether you want the lower tax rates or more exemptions and deductions.

In this year’s Union Budget, the income tax calculation underwent a complete overhaul. Not only have the tax slabs changed but also, the tax rate applicable to the lowest slab has been reduced. This sounds good but for one limitation; if you wish to avail the benefit of the lower tax rate in the new slabs then you will have to forgo certain exemptions and deductions you are eligible for. 

The good thing is that the Government has left the decision of which method to pick for tax calculation, to you. You decide whether you want the lower tax rates or more exemptions and deductions. 

Benefits of the lower tax rate

Before the change, there were effectively 4 tax slabs with 3 different rates that are applicable. The new regime has seven tax slabs with six different rates that apply. In both cases, the first income slab of income earned up to Rs 2,50,000 is liable to pay no income tax. The benefit of the new slab rate, if opted for lies for those who have a taxable income between Rs 7,50,000 and Rs 15,00,000.

However, the benefit can be clearly attributed only if one assumes that there were no deductions and exemptions availed. Accounting for the above can change the net benefit of using the new tax slabs and in some cases even negate any gains. 

What exemptions and deductions you give up?

If you opt for the new tax regime, you will give up all deductions and exemptions which you were availing till now. Everything from standard deduction of Rs 50,000 to your house rent allowance or home loan interest deduction or section 80 C deductions relating to investments, deductions relating to medical insurance premium and donations and so on. 

The impact on tax payable of individuals who give up all these will depend on the dynamics of the deductions for each individual.

However, we can go through a simple example with standard assumptions. 

Let’s say your taxable income is Rs 10,00,000. Under the old regime, assuming you don’t have any exemptions and deductions, you will have a tax payable of Rs 1,17,000 including 4% cess. Whereas, this tax liability falls to Rs 78,000 in the new regime.

However, if you are able to claim deductions and exemptions your tax payable in the older regime can potentially be much lower. 

Intuitively, it doesn’t seem wise to give up all deductions especially the ones like Sec 80 C which nudge you to maximize your investments in a year. With no tax incentive to invest, most of the surplus money and any saved on the tax liability is likely to get spent leaving you without the protection of insurance and the comfort of long-term investment. 

Here’s how. 

First, let’s assume you claim a standard deduction of Rs 50,000, Section 80 C deduction (for investment) of Rs 1,50,000 and Sec 80 D deduction of Rs 20,000 (for medical insurance premium). For the sake of simplicity, we leave aside aspects like HRA, conveyance, donations and housing loan interest. Adding these can give you even lower tax liability. 

With the above assumption, under the old tax regime, the net tax payable falls to Rs 71, 240 as compared to a higher tax liability of Rs 78,000 under the new tax regime. 

Moreover, the deductions availed are towards enhancing investments and protection, which under the new tax regime will not get rewarded.

Which way to go?

The actual net impact for each individual will have to be calculated separately for applying the new tax regime vs the old. Ideally, get a tax expert to have a look at the details. 

Intuitively, it doesn’t seem wise to give up all deductions especially the ones like Sec 80 C which nudge you to maximize your investments in a year. With no tax incentive to invest, most of the surplus money and any saved on the tax liability is likely to get spent leaving you without the protection of insurance and the comfort of long-term investment. 

At present its best to avoid that temptation. Do the calculation but ensure you don’t give up the good habit to save and invest for the uncertain lure of lower tax liability.

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