A Complete Guide to Income Taxation: What Are The 5 Types Of Income Tax?

Last Updated: 17 Oct 2024

Income taxation can be complex because a significant number of individuals generate income from a variety of sources, such as salaries, rents from properties, business profits, and capital gains. The Income Tax Act combines all your income into five separate categories—known as the “5 heads of income tax”—to provide simplicity of operation and clarity in filling in income taxes. Whether salaried, self-employed or an investor, one must know whether their income falls into one of these categories to avoid a potential misclassification mistake of the receipt, which might lead to fines.

This guide will walk over the five heads of income tax so that you understand how each kind of income is taxed and how to handle tax filing.

The 5 Types of Income Tax

1. Income from Salary
2. Income from House Property
3. Income from Profits and Gains from Business or Profession
4. Income from Capital Gains
5. Income from Other Sources

These five heads cover virtually every possible source of income, allowing the tax department to tax earnings systematically and efficiently. Let’s explore each head in detail.

1. Income from Salary

All remuneration received by way of salary in cash or reckoned as such under the head is income from salary. This head is applicable when there is an employer-employee relationship. The following are some examples of income falling under this head:

• Basic Salary:

That fixed and guaranteed regular remuneration for your job.

• Allowances:

House Rent Allowance (HRA), Leave Travel Allowance (LTA), conveyance allowance, etc.

• Perquisites:

Benefits include rent-free accommodations, company cars, etc.

• Gratuity, Bonuses, Commissions:

Any extra money you might be paid on a performance or service basis.

• Pension:

Payments made to you after retirement come under this head

Yet another benefit that you as a salaried employee have is tax exemptions from the standard deduction, HRA, and conveyance allowance that offset the cut in your taxable salary. Let’s say you are paying rent. You can take HRA so that your taxable income is reduced. 40% of the salary for rented properties located in non-metro cities, or 50% of the salary for properties in metro cities such as Mumbai, New Delhi, Kolkata, and Chennai can be deducted as HRA.

Income Taxation of Salary

Income on salary is taxable after deducting the relevant exemptions. Taxable income under this head is arrived at by adding basic salary, allowances, and perquisites followed by the deduction of exemptions in the form of HRA and the standard deduction of ₹ 50,000 for FY 2023-24. This resulting figure is the tax payable under this head.

2. Income from House Property

Income from home property is rental income resulting from your ownership of any real estate, either residential or commercial. You are expected to account for all other such properties even if you own more than one residential property but live in only one; this is because rental revenue is still due.

Important Points to Remember:

• Self-Occupied Property:

If you own and stay in one property, then the income from house property for that particular house is considered to be zero.

• Let-Out Property:

All kinds of revenues earned from letting out the property are taxable.

• Deemed Let-Out:

If one has more than one house property and one occupies more than one then one is considered as Self-Occupied while the others are declared let-out. In this case, the income of the house property is applicable even though no property is under rental.

Income Taxation from House Property

After deducting the interest paid on home loans and standard deductions—which is 30% of rental income towards maintenance—such taxable income as proceeds from the house property is estimated. If the interest expenses are greater than ₹2,00,000, a taxpayer can claim relief of up to ₹2,00,000 in his interest and expenses against the self-occupied property, therefore generating additional benefit for the taxpayer.

3. Income from Profits and Gains from Business or Profession

This head is for people or business organizations. Income from Business or Profession is the net profit that comes to you because of all the expenses allowable to your business or profession. This head applies to:

• Business Income:

Profit from a business, sales of goods, or provision of services.

• Professional Income:

Income obtained by professionals includes doctors, lawyers, consultants, etc.; earnings from freelancing and independent contractors also come in as well.

Key Deductions:

The amount arrived at after deducting business expenses from gross income is known as taxable income from business or profession. That might include office rent, water and power bills, staff pay, professional fees, and any other expenses one paid for the company. Businesspeople and self-employed individuals keep correct records of their accounting. Depending on their income level, they would file their return using ITR-3 or ITR-4.

4. Income from Capital Gains

Income through capital gains, otherwise, is considered as the amount you can make through capital assets, such as stocks, bonds, real estate, gold or mutual funds. The transaction of gains or loss under these assets is taxed under the head of capital gains since it happens in its sale.

Types of Capital Gains:

• Short-Term Capital Gains (STCG):

Short-Term Capital Gains (STCG) are taxed at applicable rates when you sell an asset within a short period, less than 24 months for property and 12 months for equity.

• Long-Term Capital Gains (LTCG):

Usually 10% or 20% depending on the asset, long-term capital gains (LTCG) are kitty of the taxman at a significantly reduced rate if you own an item beyond the allocated period.

Income Taxation of Capital Gains

For equities, short-term capital gains are taxed at 15%, while long-term capital gains exceeding ₹1 lakh are taxed at 20%. For non-equity investments such as gold and real estate, short-term gains are taxed according to the individual’s income tax slab, and long-term gains are taxed at 20% with indexation benefits.

5. Income from Other Sources

This is the catch-all category for any income that does not fall into the other four heads. Income from other sources can include:

• Interest Income:

That which is accrued through savings accounts, fixed deposits, or bonds.

• Dividend income:

It comes from mutual funds or individual shares.

• Lottery Winnings:

Cash from betting, lotteries, or gaming.

• Gifts:

Besides those from certain family members, every gift received valued more than ₹50,000 is also liable to taxes.

Income Taxation from Other Sources:

Depending on the overall income of the taxpayer, income under this head is taxed at the relevant personal slab rates.

How to Approach Income Tax Filing with the 5 Heads of Income Tax

Understanding the 5 heads of income tax is essential in correct income tax filing. When one files their taxes, all their earnings need to be declared under the right category, and deductions and exemptions need to have been factored in to reduce your tax liability at the end.

This is a step-by-step how to file income tax:

1. Classify your Income

First, identify the five heads of income and then classify all of your revenues based on them.

2. Claim Deductions and Exemptions:

Deductions include HRA to salaried individuals, interest on house loans for those who own property, and costs related to their business for self-employed people.

3. Use the Correct ITR Form:

Your need for one of the ITR forms will depend on where your income comes from. Salaried people usually need ITR-1; individuals with a company income will need either ITR-3 or ITR-4.

4. Pay Advance Tax (if necessary):

If your total tax liability in a year exceeds ₹10,000. Otherwise, you will attract interest on unpaid taxes.

5. File on Time:

Do not delay filing your taxes beyond the due date of filing the income tax return as it will attract the late fee and interest.

Conclusion

Effectively understanding the 5 heads of income taxation is indeed the crucial factor in rectifying income tax issues. Ensuring accurate categorization of income and claiming the appropriate deductions can maximize tax obligations and prevent complications during tax calculations. Whether you earn income from employment, rental property, capital gains, or a business, understanding where that income belongs in the income tax filing process will help you meet the law and potentially save money.

Frequently Asked Questions

1. What are the five heads of income tax?

Income from Salary, Income from House Property, Income from Profits and Gains from Business or Profession, Income from Capital Gains, and Income from Other Sources.

2. What is income taxed from salary?

If an individual receives income from a salary, it becomes subject to taxation once the HRA, standard deduction, and conveyance allowance have been waived. Subsequently, the remaining portion of the taxable income would be liable to taxation according to the rates of individual income tax slabs.

3. Which of the following can be deducted from income from house property?

One can claim interest on home loans up to ₹2,00,000 for self-occupied properties, a standard deduction of 30% on rental income for maintenance expenses.

4. What is capital gain taxation?

Short-term capital gains are taxed at 15% for equities and as per the income tax slab for other assets. Long-term capital gains are taxed at 20% for equities over the ₹1 lakh exemption and at 20% with indexation for other assets like gold or real estate.

5. What do you mean by income from other sources?

This includes interest income, dividend income, lottery winnings, gifts, or any other income that does not fall in the other three heads.