Which Tax Regime Should Individual Taxpayers Choose?

Last year during the Union Budget 2020 speech, finance minister Nirmala Sitaraman announced some path-breaking tax alterations. The government rolled out a new tax regime in order to provide relief to taxpayers and streamline the income tax laws. The new tax regime has more tax slabs and lower rates, but with a twist, the removal of all rebates and exemptions.

Hence, it becomes important for us to thoroughly analyse both the tax regimes before jumping to any decision. Our Gotaxfile team shall assist you in clearing the confusion and choose which regime suits you the best. So let's get started.

Introduction to the old regime

First, let us look at what individual taxpayers had to comply with before the new regime's declaration. The old tax system has higher tax rates, but the application of rebates and exemptions can reduce those. As per the Income tax Act, taxpayers have about 70 different tax deductions and exemption options to get some relief in the overall taxable income.

The most common deductions and exemptions availed are:

Exemptions	Deductions
House rent allowance	Public Provident Fund
Leave travel allowance	Life Insurance Premium
Mobile and Internet Reimbursement	Principal and Interest
Food Coupons or Vouchers	Health Insurance Premiums
Company Leased Car	Tuition fee for Children
Standard Deduction	Investment in NPS
Uniform Allowance	Saving account interest
Leave Encashment

Introduction to the new regime

Under the new tax regime, six tax slabs have been introduced with reduced prevailing rates for income up to Rs.15 lakhs. Various exemptions and deductions are not applicable here due to the income slabs and tax rates.

The new rates as per the new regime are given below:

Tax Slab(Rs.)	Old Tax Rates	New Tax Rates
0 – 2,50,000	0%	0%
2,50,000 – 5,00,000	5%	5%
5,00,000 – 7,50,000	20%	10%
7,50,000 – 10,00,000	20%	15%
10,00,000 – 12,50,000	30%	20%
12,50,000 – 15,00,000	30%	25%
15,00,000 & above	30%	30%

The new tax regime has its pros and cons.

PROS:

• Freedom to choose what suits best for you- the new regime or the old one:

The government is not forcing the new regime upon the taxpayers. Instead, it gives them the option to opt between the two according to one's own financial standards.

• Multiple tax slabs:

With the further division of existing tax slabs, the taxpayers will now be able to fit into the tax slab, which matches with your annual income more precisely.

• Flexibility to invest your money as per your preference:

Taxpayers do not have to invest their money into tax-saving schemes and insurance plans which do not resonate with their financial goals.

CONS:

• All the exemptions and deductions used in the old system will not be applicable in this new system.
• Multiple income slabs may not be beneficial for all the taxpayers if the authority decides to implement only the new tax regime.

Comparison between the two regimes

To figure out which regime suits fits best for you, consider two things :

• Exemptions availed:

One can use exemptions like phone bills, food bills, and HRA with the old regime. If you choose to opt for the new regime, you would not be eligible for these exemptions.

• Deductions claimed:

Repayment of House loans or premiums on insurance policies will also be subjected to tax if you select the new regime. The standard deduction of Rs. 50,000 and the contribution towards Employee Provident Funds (EPF), which you get as a salaried employee, will not be provided as well.

Now, find the total of such exemptions and deductions and subtract the estimated amount from your total income. The answer would be your taxable income for the new regime. In comparison, the total income with them would be the taxable income for the old regime. In this manner, way you shall be able to decide the factors impacting your income and which tax regime you should select while filing your taxes.

Let us take two hypothetical cases to understand how to see the impact of exemptions and deductions in different tax regimes.

Case 1

Sushmita has an annual income of Rs. 8,50,000. Being salaried, she makes a contribution towards EPF and claims the benefit of HRA as she is living on rent. She also incurred Rs.20,000 on traveling. She is eligible for LTA. Now let's see which regime suits her best:

Income Tax Calculation

	Old tax regime (Rs)	New tax regime (Rs)
Annual income	8,50,000	8,50,000
Standard deduction	-50,000
EPF contribution	-25,000
HRA	-30,000
Leave travel allowance	-20,000
Total (deduction and exemption)	-1,25,000
Net taxable income	7,25,000	8,50,000

Tax Slab	Old Rates	New Rates	Tax (Old)	Tax (New)
0 – 2,50,000	0%	0%
2,50,000 – 5,00,000	5%	5%	12,500	12,500
5,00,000 – 7,50,000	20%	10%	34,000	25,000
7,50,000 – 10,00,000	20%	15%		7,500
10,00,000-12,50,000	30%	20%
12,50,000 – 15,00,000	30%	25%
15,00,000 & above	30%	30%
Total taxes			34,000	32,500
Cess			1,860	1,800
Total tax need to pay			48,360	46,800

As you can see, Sushmita will be better off in the new tax system, as her tax burden will go down by Rs. 1,560

Case 2

Sunil earns Rs.20,50,000 per year. He avails a sum of Rs.1.5 lakh threshold limit under Section 80 C using his contributions to EPF and ELSS mutual funds. He also bought a health insurance plan for which he pays Rs. 25,000 as insurance premium. He claims a tax deduction in accordance with Section 80D. He is also eligible for LTA and hence claims Rs. 25,000 for LTA to be able to reduce his taxes further. He invested in NPS with Rs. 30,000.

Let us have a look at which regime best suits him:

Income Tax Calculation

	Old tax regime (Rs)	New tax regime (Rs)
Annual income	20,50,000	20,50,000
Standard deduction	-50,000
Section 80C	-1,50,000
HRA	-50,000
Leave travel allowance	-25,000
NPS	-30,000
Health insurance	-25,000
Total (deduction and exemption)	-3,30,000
Net taxable income	16,70,000	20,00,000

Tax Slab	Old Rates	New Rates	Tax (Old)	Tax (New)
0 – 2,50,000	0%	0%
2,50,000 – 5,00,000	5%	5%	12,500	12,500
5,00,000 – 7,50,000	20%	10%	50,000	25,000
7,50,000 – 10,00,000	20%	15%	50,000	37,500
10,00,000-12,50,000	30%	20%	75,000	50,000
12,50,000 – 15,00,000	30%	25%	75,000	62,500
15,00,000 & above	30%	30%	51,000	1,50,000
Total taxes			3,13,000	3,37,500
Cess			12,540	13,500
Total tax need to pay			3,26,040	3,51,000

As you can observe in this situation, the old system works better as Sunil saves Rs.24,960. Taking all these things into consideration, you shall choose your tax regime carefully.

Make a conscious and calculated decision with the help of Tax Experts from Gotaxfile!

If you are facing trouble navigating your way to the best tax regime for your personal tax needs, our team is all set to help you out. We have a solid experience and extensive knowledge to handle the complex nuances of direct and indirect taxes. Contact us today!