5 Heads of Income Tax

Filing taxes can be a troublesome task, especially when you are unsure how to categorise your earnings. With various income sources, it becomes crucial to understand which income falls under which category for taxation purposes. This is where the concept of the 5 heads of income tax comes into play. The Income Tax Act divides your earnings into different categories or heads, making it easier for both taxpayers and the government to calculate tax liabilities accurately.

So, what are these heads of income in taxation law, and how do they affect you? 

What Are the 5 Heads of Income Tax?

According to the Income Tax Act, all sources of income fall under 5 main categories known as heads of income. These categories help streamline the process of calculating taxable income, ensuring that every type of earning is accounted for. The 5 heads of income tax are:

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

Each of these heads of income in taxation law covers a different type of earning, and it’s essential to understand how they work.

1. Income from Salary

Income from Salary is perhaps the most straightforward of all the heads. This head covers all the income you receive as part of your employment. If you are employed and receive a salary, wages, commissions, bonuses, or even pensions, these earnings fall under this head of income.

According to the Income Tax Act, any income that you receive as part of your employment contract is considered income from salary. This includes basic pay, advance salary, gratuities, pensions, and perquisites like company cars, housing, or meal allowances. Sections 15 to 17 of the Income Tax Act govern the taxation of salary income. Here are some key aspects to note:

• Section 15 defines what constitutes income from salary.
• Section 16 lays out the deductions available under this head, such as the standard deduction and professional tax.
• Section 17 explains various components of salary, including monetary compensation, perquisites, and allowances.

Exemptions such as House Rent Allowance (HRA) and Transport Allowance can help reduce your taxable salary. For instance, if you pay rent, you can claim HRA to lower your taxable income. In specific cases, like if you are visually or physically handicapped, you can also claim a transport allowance of ₹1,600 per month.

The income details falling under this category must be entered in Schedule S of your ITR (Income Tax Return) form.

2. Income from House Property

If you own a house or any real estate that generates income through rent, this earning falls under Income from House Property. This head of income is applicable even if the property is not rented out but is capable of generating income.

Your property can be classified into three types under this head of income:

1. Self-occupied Property: A property that you live in.
2. Let-out Property: A property that you rent out.
3. Deemed Let-out Property: A property that is not rented out but is deemed to generate income if you own more than two properties.

Even if you are living in a self-occupied house, you can claim deductions for home loan interest payments. However, if you own multiple properties, only two can be declared as self-occupied; the rest will automatically be considered as deemed let-out.

Income from rental property is taxed after deducting 30% as a standard deduction for repairs and maintenance. The remaining amount is your taxable income under this head. You need to declare these details in Schedule HP of your ITR form.

3. Income from Profits and Gains from Business or Profession

This category applies to individuals, partnerships, or corporations involved in any form of trade, business, or profession. All earnings from business operations or professional services come under this head of income.

Under this head, income is calculated by deducting business-related expenses from the total revenue. Allowable deductions include salaries, rent, depreciation of assets, and expenses on utilities. Here’s a breakdown of what qualifies as income from business or profession:

• Profits from trading or business
• Earnings from professional services
• Income from a partnership firm
• Any profits from selling licenses

The Income Tax Act provides flexibility in deducting business-related expenses. This helps businesses reduce their taxable income significantly. All business professionals must file their income under ITR-3 or ITR-4, and disclose these earnings in Schedule BP of the ITR.

4. Income from Capital Gains

If you have made a profit by selling assets like property, shares, gold, or mutual funds, this income is classified under Income from Capital Gains. Capital gains are profits earned by selling assets that have appreciated in value over time.

Capital gains are divided into two types:

1. Short-term Capital Gains: Profits from selling assets held for a short period (e.g., stocks held for less than 12 months).
2. Long-term Capital Gains: Profits from selling assets held for a longer duration (e.g., real estate held for more than 24 months).

The tax rates for capital gains vary based on the type of asset and the holding period. For example, long-term capital gains from listed equity shares are taxed at 12.5%, whereas short-term gains are taxed at 20%. Capital gains must be reported in Schedule CG of your ITR form.

5. Income from Other Sources

Any income that does not fall under the other four heads is taxed under Income from Other Sources. This is a residual category, covering earnings like:

• Interest on savings or fixed deposits
• Dividends from shares or mutual funds
• Income from lotteries, gambling, and card games
• Gifts above a certain value

This head is essential for accounting for miscellaneous earnings. While dividends and interest are common, windfall gains like lottery winnings or gambling earnings are also taxable under this category. These earnings are reported in Schedule OS of your ITR form.

Heads of Income vs Sources of Income

It’s important to understand the difference between heads of income and sources of income. While heads of income refer to the categorisation of your earnings for tax purposes, sources of income are the actual means through which you earn your income.

For example:

• Head of income: Income from Salary
• Source of income: Salary paid by your employer

Understanding this difference can help you categorise your earnings correctly, ensuring accurate tax calculation.

Conclusion

Understanding the 5 heads of income tax is crucial for anyone looking to file their taxes accurately. Each head of income has its own rules for exemptions, deductions, and tax rates, making it important to correctly categorise your income. Whether it’s income from salary, rental income from house property, or profits from selling investments, knowing which head of income applies to your earnings can help you minimise your tax liability and avoid penalties. So, next time you’re filing your taxes, make sure to classify your income correctly under these heads.

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