Who should opt for the new tax regime?

The union budget presented by the Finance Minister contained a few Income Tax benefits for the the taxpayers who opt for the new tax regime. The new tax regime was introduced in the budget 2020 as an option for the taxpayer who opt to forgo the exemptions and deductions enjoyed in the old scheme. It comes with a lower tax rates to compensate this. However there were no much takers for the new regime. In this budget it was announced that the new tax regime will be the default one with option of continuing with the old one.

So the question is who should opt for the new tax regime?

The new tax regime was beneficious for tax payers in the lower side of the income with not much of savings. This budget has reduced the tax in the new tax regime so that the income limit for the benefits is pushed to a higher side. Added to the reduced tax rates, a standard deduction of ₹ 52500 has being introduced for those who are having income above ₹ 15.5 lakhs.

For comparison we have to look at what is the maximum deduction one must claim in the old tax regime so that the income tax payable in both the regimes are the same.

According to analysis, if the maximum exemptions and deductions claimed by salaried individuals is more than ₹ 4.25 lakh, including the standard deduction of ₹ 50,000/- for an income above ₹ 15.5 lakh, then he/she may pay less tax in the old tax regime from FY 23-24. 

For lower income levels, the limit for opting the old scheme decreases due to the lower rates.

Here is an analysis showing the maximum deductions a salaried individual needs to claim to remain tax neutral in both the income tax regimes.

In the previous tax system, a person with a salary income of Rs. 7.5 lakh might reduce their taxable income to Rs. 5 lakh by claiming the maximum permitted exemptions and deductions of Rs. 2.5 lakh. As a result, he no longer owes any taxes and is qualified for a rebate under Section 87A of the previous tax code. If the same person chooses the updated new tax regime, they will be eligible for the standard deduction of Rs. 50,000 (introduced for the new tax regime), a Section 87A rebate (for income up to Rs. 7 lakh), and will owe no taxes.

Similarly, if an individual with a gross income of Rs.10 lakh opts to claim deductions and exemptions such as Section 80C, 80D, 80TTA, HRA exemption, LTA exemption for a maximum of Rs.3 lakh, then he/she turns tax neutral in both the tax regimes. If the deductions claimed is less than Rs.3 lakh, then the new tax regime will be beneficial for such a salaried taxpayer.

Similarly, the amount of tax payable will be the same under the old tax system and the updated new income tax slabs for salaried individuals with income of Rs.12.5 lakh and who are eligible for deductions (Section 80C, 80D, 80E, 80TTA, etc.), tax exemptions on HRA, LTA, and standard deductions of Rs.50,000 for a maximum total of Rs.3,62,500. It is preferable to choose the revised new income tax system if the amount of the deduction claimed is less than Rs 3,62,000.

A salaried individual having a gross income of Rs.15 lakh must claim deductions of more than Rs 4,08,332 to make the old tax regime beneficial for him/her. If the person has a gross income of Rs.20 lakh, then the deductions claim must be for more than Rs 4,25,000 to make the old tax regime beneficial.

Also read: Income Tax changes - Is there really any benefit?