A Breakdown of the Five Heads of Income

Understanding the five sources of income is crucial for effective tax planning and compliance. These categories help individuals and businesses organise their income for accurate tax reporting. Utilising the services of a tax advisor or an online tax advisor can simplify the process, ensuring that all sources of income are correctly identified and reported. This post breaks down the five heads of income, providing a clear understanding of each category.

Income from Salary

Income from salary includes all earnings from employment, such as wages, salaries, bonuses, commissions, and pensions. Specific sections of the Income-tax Act govern it:

• Section 15: Taxability of income from salary.

• Section 16: Deductions available under wages.

• Section 17: Components of salary like monetary compensation and perquisites.

There are also exemptions available under this head:

• House Rent Allowance (HRA): Salaried individuals living in rented houses can claim HRA for partial or complete tax exemptions.

• Transport Allowance: Blind, deaf, and orthopedically handicapped employees can claim a Rs 1,600 monthly allowance.

Tax on salary income is calculated using the information provided in Schedule S of the ITR form. Additionally, allowances for special occasions and performance-based bonuses may also be eligible for tax deductions, further reducing the taxable income.

Income from House Property

Moving to another source from the five heads of income, Income from house property includes rental income from properties owned by an individual. It is categorised into three sub-classifications:

• Self-Occupied Property: Property used for personal residence.

• Let Out Property: Property rented to tenants.

• Deemed Let Out Property: If an individual owns more than two self-occupied houses, the additional properties are deemed let out.

Income from both commercial and residential properties is taxable under this head. Details of house property income must be declared in Schedule HP of the ITR form. In addition, deductions for home loan interest and standard deductions for repairs and maintenance can be claimed to reduce the taxable income from house property.

Income from Profits and Gains from Business or Profession

This head includes profits earned from any business or professional activities. Taxable income under this category is calculated by subtracting business expenses from total income. Types of income under this head include:

• Profits from the sale of licences.

• Gains during an assessment year.

• Earnings from business operations.

• Cash incentives from government schemes.

• Benefits received by a business.

• Partnership earnings.

Individuals or HUFs earning income from business and profession must file ITR-3 or ITR-4. Additional deductions can be claimed for expenses like rent, utilities, salaries, and office supplies, further reducing the taxable income under this head.

Income from Capital Gains

Income from capital gains arises from selling or transferring capital assets like real estate, stocks, bonds, mutual funds, and gold. Capital gains are divided into two categories:

• Short-term Capital Gains: Profits from assets held for a short period.

• Long-term Capital Gains: Profits from assets held for a longer period.

The holding period and tax rates for different asset classes are as follows:

Details of capital gains must be disclosed in Schedule CG of the ITR form, and individuals must file ITR 2 or 3. Additionally, the indexation benefit for long-term capital gains helps adjust an asset's purchase price to inflation, thereby reducing the taxable gain.

Income from Other Sources

This category includes all other income not covered under the previous heads. Section 56 sub-section (2) of the Income-tax Act governs this head, which includes:

• Dividends.

• Interest from savings accounts or fixed deposits.

• Rent from plant and machinery.

• Lottery winnings.

• Gambling and card game earnings.

• Sports rewards.

This head also includes income from gifts received if their total value exceeds a specified limit and family pensions received by legal heirs. Other examples include income from subletting, commission income unrelated to business or profession, and director’s fees. This category captures miscellaneous incomes, ensuring that all potential sources of earnings are accounted for in tax filings.

Conclusion

Understanding the five sources of income is essential for accurate tax filing and maximising tax benefits. Knowing how to categorise your income can help in proper tax planning and compliance, whether you are an individual or a business. Consulting with a tax advisor or using an online service can simplify this process, ensuring that your income is correctly classified and reported.

By utilising financial professionals' expertise, you can easily overcome the complexities of tax filing, ensure compliance, and optimise your financial strategy. This approach helps reduce tax liabilities and maximise returns, improving financial health and stability.