What Is Income Tax? How the Government Actually Decides What You Owe

Income tax is a direct tax levied by the government on the income earned by individuals and entities during a financial year. In India, it’s governed by the Income Tax Act, 1961, and administered by the Income Tax Department under the Central Board of Direct Taxes (CBDT). Your income tax liability depends on how much you earn, what type of income it is (salary, business profit, capital gains, rental income, and so on), and which deductions or exemptions you’re eligible to claim.

Most salaried employees experience income tax indirectly, through Tax Deducted at Source (TDS), where the employer deducts an estimated tax amount from each month’s salary and deposits it with the government on the employee’s behalf.

Old regime versus new regime

India currently allows individual taxpayers to choose between two tax regimes each year: the old regime, which has higher tax rates but allows a wide range of deductions and exemptions (like Section 80C investments, HRA, and home loan interest), and the new regime, which has lower tax rates but strips out most deductions and exemptions. The new regime has been the default option since the changes introduced in recent Union Budgets, though taxpayers can still opt into the old regime when filing, subject to eligibility rules that differ slightly for salaried individuals versus those with business income.

Which regime works out cheaper depends entirely on how many deductions you’d actually claim under the old regime; someone with significant 80C investments, HRA, and a home loan may still come out ahead under the old regime, while someone with few deductions typically benefits from the new regime’s lower rates.

How tax slabs actually work (the part most people misunderstand)

India uses a progressive, slab-based system, which means your income is taxed in layers, not as a single flat rate applied to your entire income. Under the new tax regime structure introduced for FY 2025-26 (AY 2026-27), income up to ₹4 lakh is untaxed, with subsequent slabs taxed at progressively higher rates (5%, 10%, 15%, 20%, 25%, and 30%) as income rises through defined bands, up to a top rate of 30% on income above ₹24 lakh. A rebate under Section 87A can bring the effective tax liability to zero for total income up to ₹12 lakh under the new regime (before cess), meaning many taxpayers in that range pay no net tax despite the slab structure technically applying tax to portions of that income. Because tax slabs and rebate thresholds are revised almost every Union Budget, always confirm the applicable slabs for the specific financial year you’re filing for on the Income Tax Department’s website.

The key misunderstanding to clear up: moving into a higher slab does not mean your entire income gets taxed at the higher rate. Only the portion of income that falls within that higher slab is taxed at that rate; everything below it continues to be taxed at the lower rates that applied to those earlier slabs. This is why earning a raise that pushes you into a higher slab virtually never results in a lower take-home amount overall.

Income tax versus other taxes you might confuse it with

Income tax is a direct tax on what you earn. It’s distinct from Goods and Services Tax (GST), an indirect tax on what you spend, and from Tax Deducted at Source (TDS), which isn’t a separate tax but a collection mechanism for income tax (and certain other payments) deducted at the point of payment rather than at the end of the year.

Filing is separate from paying

Even if all your tax has already been deducted as TDS, you’re still generally required to file an Income Tax Return (ITR) each year if your income exceeds the basic exemption threshold, declaring your total income, claiming any additional deductions, and reconciling what was actually deducted against what you actually owe. Filing late or not at all can trigger interest, penalties, and in some cases restrict your ability to carry forward certain losses for future tax years.

Bottom Line

Income tax in India is a progressive, slab-based system administered under a choice of two regimes, and the amount you actually owe depends heavily on which deductions and exemptions you’re eligible for and choose to claim. Because rates, slabs, and rebate thresholds change with nearly every Union Budget, the specific numbers are worth reconfirming each year rather than assuming last year’s structure still applies.

This article is for general information and isn’t personalized tax advice. Consult a qualified tax professional or chartered accountant for guidance specific to your situation.

Sources

• Income Tax Department, Government of India
• Ministry of Finance – Union Budget