Impact of the New Income Tax Regime on Salaried Employees

Impact of the New Income Tax Regime on Salaried Employees: Analyzing How the Revised Tax Slabs and Exemptions Affect Salaried Individuals

Introduction

If you received news that you would have to pay less taxes starting tomorrow for the same income you received, one would be elated. A new tax regime facades as beneficial, especially for high taxpayers – the prospect of paying less taxes is one that deems individual household income more promising; however, the drawbacks of the new tax slab do not appear immediately apparent. The new regime, even though it comes with a set of reduced tax rates, also comes with significantly fewer exemptions. Taxpayers can choose whether they want to conform to the old or new tax system – however, many are oblivious to the many exemptions that come with reduced tax paying.

Background

The alternative new income tax regime in India launched in the Financial Year (FY) 2020-21 aims to simplify tax compliance by providing a more straightforward approach to it. We have all experienced the chaos around tax form filing time; as part of the old regime, taxpayers had to go through the process of deductions, exemptions, and allowances, all to optimize their tax returns – often requiring professional help while subsequently being a hassle. By being more inclusive of different tax slabs and having lower tax rates, the regime seeks to eliminate this. The thought behind the system is to create a more user-centric, user-friendly system, encouraging voluntary compliance and reducing tax filing errors and disputes. This regime can make the tax filing process for both the taxpayers and the tax file processing institutions a lot simpler.

Revolving around the point of ‘encouraging compliance,’ taxpayers are also under the semblance that they have an option – which they essentially do. As described by Edward Deci and Richard Ryan in the 1980s, the self-determination theory puts up the effect of individuals having a choice. When they assume they have a choice, it is shown that they comply better with the rules set out – a similar case is happening here. Individuals have no choice but to pay tax, but the pretense of having different options in which way and how much tax they pay leaves them under the impression of free will, inclining them to cooperate more with the system.

Through this article, I aim to analyze the old and new tax slab policies and amplitudes in which the exemptions impact salaried employees. The new income tax regime affects salaried employees’ tax planning, disposable income, and financial goals, making it essential to understand for informed decision-making.

Overview of the New Income Tax Regime

The new income tax regime presents a streamlined structure with revised tax slabs, eliminating many familiar exemptions and deductions, such as HRA, Section 80C for investments, and Section 80D for medical insurance. Unlike the old regime, which encouraged savings and investments through tax exemptions, the new regime offers lower tax rates in exchange for simplicity, appealing to those who prefer a straightforward approach without the traditional tax-saving provisions. 

Taxpayers now face a choice each financial year: continue with the old regime, leveraging various deductions to reduce taxable income, or opt for the new, exemption-free system with reduced rates. This optionality allows individuals to choose the regime that best suits their financial strategies and personal tax goals for the year, aligning with the aim of greater simplicity and autonomy in tax planning.

Key Changes in Tax Slabs and Exemptions

The new income tax regime’s revised tax slabs introduce rates ranging from 5% to 30%, with incremental increases across income levels designed to lower the tax burden at each threshold. However, with the removal of several key exemptions and deductions, salaried employees might find the reduction in tax rates offset by the loss of benefits. 

The regime excludes the standard deduction, House Rent Allowance (HRA) exemptions, and deductions under Section 80C—previously used for tax-saving investments in life insurance, Equity-Linked Savings Schemes (ELSS), and Public Provident Fund (PPF)—as well as medical insurance deductions under Section 80D. Notably, some benefits remain, such as contributions to the National Pension System (NPS) and employer contributions to the Employee Provident Fund (EPF), allowing taxpayers to retain limited options for tax-saving while adjusting to the revised rates and structure.

Impact on Salaried Employees: A Comparative Analysis

The new tax regime can offer tangible benefits for low-income employees (e.g., income below INR 5 lakhs). With reduced tax rates and simplified compliance, employees in this bracket may experience little or no tax liability, particularly given the rebate under Section 87A, which can reduce the tax to zero for incomes up to INR 5 lakhs. For instance, a hypothetical low-income earner might find that the new regime’s lower rates suit them well without the need for deductions or exemptions, making tax filing less complex and financially advantageous.

For middle-income employees (e.g., incomes between INR 5 lakhs and INR 15 lakhs), the decision to opt for the new regime becomes more nuanced and often depends on personal financial strategies. While the new regime’s lower rates might initially seem appealing, this group could benefit more from the old regime if they have substantial deductions—such as those under Sections 80C, 80D, and HRA. A middle-income employee with significant investments or deductions may find that sticking with the old regime provides a lower net tax liability compared to the new regime’s straightforward but deduction-free structure.

High-income employees (e.g., income above INR 15 lakhs) may see mixed results under the new regime. The removal of high-value exemptions and deductions, which many in this bracket previously claimed extensively, can lead to a higher effective tax liability. Case studies often reveal that high-income earners who maximized deductions under the old regime—such as high contributions to NPS, EPF, life insurance, and more—could face a higher tax outflow under the new system despite its lower rates. Consequently, for high-income earners with extensive tax-saving investments, the old regime may remain more financially beneficial.

Considerations for Choosing Between the Old and New Regimes

When deciding between the old and new tax regimes, several factors can influence the choice, including annual income, the extent of tax-saving investments, eligible deductions, and personal financial goals. For lower-income employees with minimal investments, the new regime’s lower rates without deductions might be advantageous, offering simplicity and comparable tax outcomes. 

Middle-income earners with moderate investments may benefit from the old regime, where deductions for expenses like health insurance or home loan interest can substantially lower their tax liability. High-income earners, particularly those with significant deductions across categories such as Section 80C and housing loans, are often better served by the old regime, as these deductions can offset higher income more effectively. Tools like tax calculators can further assist employees in assessing these variables, providing a personalized analysis to help determine the most tax-efficient regime based on individual circumstances.

Practical Implications for Salaried Employees

The new income tax regime presents several practical implications for salaried employees, particularly in terms of financial planning and budgeting. With the revised tax slabs reducing the benefits of traditional tax-saving investments such as Public Provident Fund (PPF) or Equity-Linked Savings Scheme (ELSS), employees may shift their investment behavior, seeking alternative avenues that offer better returns without tax incentives. 

This shift could lead to changes in budgeting as employees adjust to the absence of deductions previously available, potentially reallocating funds toward non-traditional investment options or saving strategies. Additionally, employers may respond to these changes by reevaluating their salary structures and benefits packages, possibly introducing new tax-saving schemes to attract and retain talent. 

For future tax planning, salaried individuals must adopt proactive strategies, such as investing in tax-efficient financial instruments or rethinking their overall financial goals, to optimize their tax savings in light of the new regime. This adaptability will be crucial for navigating the evolving landscape of personal finance under the revised tax framework.

Criticisms and Limitations of the New Regime

The new income tax regime has faced several criticisms and limitations, primarily centered on the perceived reduction in incentives for savings and investment. With fewer deductions available, many argue that the regime discourages individuals from investing in long-term savings instruments, potentially undermining financial security for the future. Additionally, the introduction of a dual regime system has led to complexity and confusion among taxpayers, as individuals struggle to navigate between the old and new frameworks and determine which option is more beneficial for their financial circumstances. 

In response to these criticisms, government officials and tax experts have emphasized the regime’s goals of simplifying the tax process and enhancing compliance by offering lower tax rates on direct income. They argue that by streamlining the tax structure, the government aims to foster a more efficient system that minimizes evasion and promotes a fairer distribution of the tax burden. Despite the criticisms, proponents of the new regime believe it provides a clearer, more straightforward approach to taxation that can ultimately benefit taxpayers in the long run.

Conclusion

In conclusion, the analysis of the new income tax regime reveals key insights into its potential benefits and challenges for salaried employees. Notably, employees with lower incomes or those who do not extensively utilize tax deductions may find the new tax slabs advantageous, as they can enjoy lower tax rates without the burden of navigating complex deductions.

Conversely, higher-income earners or those traditionally relying on deductions may need to reevaluate their financial strategies to adapt to the revised framework. 

To optimize their tax positions under the new regime, salaried employees are encouraged to thoroughly review their financial plans, explore tax-efficient investment options, and consider potential adjustments to their budgeting practices. It is essential to remain vigilant for any anticipated changes or adjustments to the tax regime, as the government may continue to refine policies based on taxpayer feedback and economic conditions. Such adjustments could further influence the financial landscape for salaried individuals, making it crucial for them to stay informed and adaptable in their tax planning efforts.