New income tax regime: Should you switch?

Should you remain in the old tax regime or opt for the new one provided by the Budget?

On the face of it, lower tax rates in the new regime should ideally translate into lesser tax. But that might not be the case for many. That’s because in the new regime, you will have to forgo most tax breaks. These include key deductions such as Section 80C (investments, expenses, life insurance premium of up to ₹1.5 lakh), Section 80D (health insurance premiums of up to ₹25,000 for those under 60 and ₹50,000 for senior citizens), Section 24 (home loan interest of up to ₹2 lakh), Section 80CCD (including extra NPS (National Pension Scheme) contribution of up to ₹50,000), Section 80E (education loan interest), and Section 16 (standard deduction on salary income of ₹50,000). You will also have to forgo the benefits of most exemptions under Section 10 such as house rent allowance and leave travel concession. You have to take into account the impact of these tax breaks on your final tax liability before deciding to switch or stay.

Decision matrix

Here’s a way to know whether you should continue with the old tax regime or shift to the new one.

Essentially, you have to know the break-even amount of deductions and exemptions — at which your tax liability under the old regime and the new regime will be the same. Make a list of and sum up the deductions and exemptions that you plan to use. If the total of these exceeds the break-even amount, you will be better off in the old regime. On the other hand, if the total is below the break-even number, you should consider shifting to the new tax regime.

For instance, consider an individual, less than 60 years old, with gross annual income of ₹15 lakh. If the deductions and exemptions claimed by this person total ₹2.5 lakh a year, the taxable income under the old regime becomes ₹12.5 lakh and the tax liability will be ₹1.95 lakh. Under the new regime, without the benefit of these deductions and exemptions, the person’s taxable income will be ₹15 lakh, but thanks to lower tax rates, the tax liability will be the same — ₹1.95 lakh. Thus, at this break-even level of tax benefits, it makes no difference whether the person stays in the old regime or shifts to the new one.

Now, if the person’s tax breaks exceed ₹2.5 lakh, say, ₹3 lakh, his taxable income under the old regime will come down to ₹12 lakh and the tax liability will be ₹1,79,400, while under the new regime, the tax liability will be ₹1.95 lakh. So, it will be better to continue with the old regime. On the other hand, if the tax breaks of this person are below ₹2.5 lakh, say ₹2 lakh, his taxable income under the old regime will be ₹13 lakh, and the tax liability will be ₹2,10,600; this is higher than the tax liability of ₹1.95 lakh under the new regime. In this case, it will be worthwhile to shift to the new regime.

Recommendation: Continue with the old tax regime if your tax deductions and exemptions equal or exceed the above-mentioned break-even levels. Go for the new tax regime if the tax deductions and exemptions are below the above-mentioned break-even levels

The break-even amount of tax breaks for various income levels and taxpayer categories is given in the accompanying table. Note that the break-even levels are lower for senior citizens and super-senior citizens, since they enjoy higher basic income exemption limits (₹3 lakh and ₹5 lakh respectively) compared with others (₹2.5 lakh) in the old regime, but not in the new one.

Many people under 60 would likely be taking tax breaks of ₹2.5 lakh or more a year using some key benefits such as standard deduction on salary, Section 80C, additional deduction on NPS investment, and health insurance premium. They should continue with the old regime. If other tax breaks such as home loan interest are also available, it will only bolster the case for sticking with the old tax regime.

So, whom will the new tax regime be suitable for? It might be good for those who may be finding it difficult to save and invest adequately, to the extent of the break-even level of their tax breaks. For instance, some young people starting out on their jobs, or some retired senior citizens who do not get the benefit of standard deduction on salary, and don’t invest in tax-saving investments.

Flexibility

You can continue with the old regime, and move to the new regime in future years if it works to your benefit. Also, if you have no business income, you can make the choice between the old and the new regime every year. But if you have business income, once you have made the choice to shift to the new regime, you will have to continue with it in future years.