Detailed Guide to Headwise Computation of Income

Every rupee you earn in a financial year has to fit into one of five boxes before the Income Tax Department can tax it. This classification isn’t just an academic exercise for your exam paper – it decides which expenses you can claim, which losses you can adjust, and ultimately how much tax you pay. If you mix up which box your income belongs to, you could end up losing a legitimate deduction or, worse, under-reporting your tax liability. This guide walks you through how each head of income is computed and how the pieces come together to form your total income.

Why income is split into five heads 🔗

Salary, rent, business profit, capital gains, and interest income don’t behave the same way. Salary is fairly predictable and taxed after standard deductions. Business income fluctuates and depends heavily on expenses. Capital gains depend on how long you held an asset before selling it. Because of these differences, the law groups all income into five defined categories, each with its own computation method, allowable deductions, and exemptions, so that the right rules apply to the right kind of earning, as explained by tax law analysts covering this classification.

This structure isn’t new. It has existed since the Income Tax Act, 1961 came into force, and it continues under the Income Tax Act, 2025, which received presidential assent and took effect from 1 April 2026, replacing the 1961 Act for all income earned from that date onward. The five heads themselves haven’t changed; only the section numbers and the way the law is worded have been reorganised for clarity, as summarised in this overview of the new Act’s structure.

The five heads at a glance 🔗

Before diving into computation rules, here’s a quick snapshot of what falls where.

Income from salaries 🔗

If you receive money from an employer for services rendered under a contract of employment, it falls here. This includes basic pay, dearness allowance, bonus, commission, leave encashment, and the value of perquisites such as rent-free accommodation. What it does not include is income earned as an independent professional, since that lacks an employer-employee relationship and instead falls under business or profession.

Computation is fairly simple: you add up gross salary and perquisites, then subtract the standard deduction. As of the current financial year, salaried taxpayers can claim a flat standard deduction of ₹75,000 under the new tax regime, compared to ₹50,000 under the old regime, without having to furnish any bills or proof, as confirmed by this summary of standard deduction rules. The Income Tax Department’s own guidance for salaried individuals also lays out how allowances like house rent allowance and leave travel allowance are treated depending on the regime you choose.

A note on regime choice 🔗

Since the new tax regime is now the default, most first-time filers will automatically get the higher ₹75,000 deduction unless they actively opt for the old regime, which allows more exemptions like HRA and LTA but caps the standard deduction lower.

Income from house property 🔗

Own a flat, shop, or a plot with a building on it? Any rent you earn – or could reasonably earn even if the property is lying vacant – is taxed under this head. The only exception is a property you use for your own business, which moves to the business head instead.

Computation starts with the Gross Annual Value (the higher of actual rent received and fair rental value), from which municipal taxes paid are subtracted to arrive at Net Annual Value. From this, a flat 30% standard deduction is allowed regardless of your actual maintenance costs, followed by a deduction for interest paid on a home loan. For a self-occupied house, this interest deduction is capped at ₹2 lakh a year, a rule that has carried over unchanged into the new Act, according to this detailed walkthrough of house property computation.

Profits and gains of business or profession 🔗

This head covers income from trading, manufacturing, or rendering professional services such as consultancy, medical practice, or legal work. Computation follows commercial accounting principles: you start with net profit as per your books and adjust it for items the tax law treats differently, such as disallowed personal expenses or depreciation calculated under tax rules rather than accounting rules.

Expenses that are wholly and exclusively incurred for the business – rent, salaries paid to staff, repairs, insurance – are deductible. Depreciation on assets used in the business is allowed as per prescribed rates, and unlike accounting depreciation, it follows the block-of-assets method laid down in the tax law. Small businesses and professionals below specified turnover limits can also opt for a presumptive taxation scheme, which estimates profit as a fixed percentage of turnover instead of requiring detailed books, a compliance simplification that this explainer on the five heads touches on as well.

Capital gains 🔗

Sell a capital asset – property, listed shares, mutual fund units, gold, or a business undertaking – and any profit you make is taxed as capital gains. The computation depends heavily on how long you held the asset. Assets held beyond a specified period qualify for long-term treatment, which usually attracts a lower tax rate and, for certain assets, the benefit of indexation to adjust the cost for inflation. Assets sold sooner are taxed as short-term gains, generally at higher rates.

For listed equity shares and equity mutual funds specifically, short-term gains are currently taxed at 20%, while long-term gains above ₹1.25 lakh in a year are taxed at 12.5%, rates that the Income Tax Act, 2025 has carried forward from the earlier framework without change, as detailed in this breakdown of capital gains rules. Exemptions are also available if you reinvest the gains into another residential house or into notified bonds within the prescribed time.

Income from other sources 🔗

Think of this as the residuary head – anything that doesn’t fit into the four heads above lands here. Interest on savings accounts and fixed deposits, dividends, family pension, lottery winnings, and gifts exceeding ₹50,000 from non-relatives all fall under this category. Not everything here is taxed the same way; lottery and game-show winnings, for instance, attract a flat rate rather than the slab rate applicable to interest income.

Deductions are limited but real. For example, a standard deduction applies to family pension, and expenses directly connected to earning income under this head, such as commission paid to collect interest, can be claimed.

Multiple sources within one head: compute separately, then add up 🔗

Here’s where students often stumble. If you own two rented flats, you don’t calculate one combined figure straight away. You compute income separately for each property – its own Gross Annual Value, its own municipal taxes, its own interest deduction – and only then add the two results together to get your total income from house property. The same logic applies if you run two different businesses, or hold multiple fixed deposits generating interest.

This source-wise computation matters because deductions and exemptions are often source-specific. A loss on one rented flat and a profit on another can’t simply be averaged out before applying deductions; each has to be worked out on its own terms first.

Setting off losses within the same head 🔗

Once you’ve aggregated income within a head, the law allows you to set off a loss from one source against a gain from another source within that same head, as shown in the table above. This is called intra-head set-off, and it generally applies freely, with a few important exceptions.

Losses from speculative business can only be set off against gains from another speculative business, not against regular business profits. Long-term capital losses can only be adjusted against long-term capital gains, though short-term capital losses can be set off against both short-term and long-term gains. Under the current new tax regime, a loss from house property also can’t be set off against salary or other income outside the head; it can only be adjusted against other house property income or carried forward, a restriction spelled out in this guide to house property loss rules. The Income Tax Act, 2025 continues to group these set-off and carry-forward provisions under a dedicated chapter, keeping the underlying logic intact even as section numbers have shifted.

What comes after intra-head set-off 🔗

Once each head’s income is finalised, the five figures are added together to arrive at your Gross Total Income. From there, inter-head set-off (adjusting a loss from one head against income from a different head, subject to conditions) and Chapter VI-A style deductions come into play before you reach your final taxable income. That’s a computation exercise in its own right and builds directly on the head-wise groundwork covered here.

What do you think? If you owned a rented flat that generated a loss this year, would you rather set that loss off immediately against other property income, or carry it forward to a year when you expect stronger rental income? And now that the Income Tax Act, 2025 has renumbered these provisions without changing their substance, do you think simplifying the law’s structure alone is enough to reduce disputes between taxpayers and the tax department?

References

1. https://taxguru.in/income-tax/heads-income-income-tax-act.html
2. https://www.newsonair.gov.in/income-tax-act-2025-gets-presidents-assent-will-be-effective-from-1st-april-2026
3. https://cleartax.in/s/income-tax-act-2025
4. https://tax2win.in/guide/standard-deduction-salary
5. https://www.incometax.gov.in/iec/foportal/help/individual/return-applicable-1
6. https://taxgarden.in/blog/income-from-house-property-itr-schedule-hp-ay-2026-27
7. https://www.mstock.com/articles/5-heads-of-income-under-income-tax-act