Income tax guide: How deductions, exemptions, and rebates work under old and new tax regimes?

For taxpayers eligible to choose between the old and new tax regimes, receipt of Form 16 presents an opportunity to undertake a final comparative computation under both regimes before filing the income-tax return.

The Income-tax Act provides taxpayers with a choice between the old tax regime and the new tax regime. While both regimes are designed to compute an individual’s tax liability, the key difference lies in the availability of exemptions, deductions, and rebates.

The old tax regime allows taxpayers to claim a wide range of exemptions and deductions, whereas the new tax regime offers comparatively lower tax rates and a simplified structure with limited tax benefits. Therefore, taxpayers should clearly understand the distinction between exemptions, deductions, and rebates before choosing a regime.

Deductions – Deductions reduce the Gross Total Income before tax is calculated

Exemptions – Exemptions reduce the amount of income that is taxable

Rebate under Section 87A – A rebate differs from exemptions and deductions as it directly reduces the tax payable.

“As a broad principle, the old tax regime may be beneficial for taxpayers who regularly claim significant exemptions and deductions, while the new tax regime may suit those who prefer a simplified tax structure and do not have substantial tax-saving investments or eligible deductions,” said Sandeep Bhalla, Partner, Dhruva Advisors.  
Taxpayers should evaluate their tax liability under both regimes before making a choice.
 

Deductions and Exemptions

Under the old tax regime, taxpayers can avail a wide range of deductions and exemptions, thereby reducing taxable income. Common exemptions include House Rent Allowance (HRA), Leave Travel Allowance (LTA) and certain allowances available to salaried individuals. 

Further, deductions may be claimed under provisions such as section 80C (for investments like provident fund, life insurance premium, ELSS, principal repayment of housing loan, etc.), section 80D (medical insurance premium), section 24(b) (interest on self-occupied housing loan), and eligible contributions to pension schemes under section 80CCD(1B), among others. In exchange for these tax breaks, the old regime generally applies comparatively higher slab rates.

The new tax regime, on the other hand, offers concessional tax slab rates but significantly restricts the availability of deductions and exemptions. Most common exemptions and deductions available under the old regime are not permitted. 

However, certain benefits continue to remain available even under the new regime, including the standard deduction (enhanced to Rs. 75,000), employer contribution to the National Pension System (NPS) under prescribed conditions, and deduction in respect of the employer’s contribution to EPF / NPS / superannuation funds within overall limits. 

The regime is intended to simplify tax compliance for individuals who do not have substantial deductions to claim.

Rebate

Under the old tax regime, a resident individual is eligible to claim a rebate under Section 87A if the taxable income does not exceed Rs. 5 lakh. The maximum rebate available is Rs. 12,500 or the amount of income-tax payable, whichever is lower. Consequently, an individual with taxable income up to Rs. 5 lakh may effectively have no tax liability after claiming the rebate.

Under the new tax regime, the scope of the rebate is more beneficial. For FY 2025-26 (AY 2026-27), a resident individual whose taxable income does not exceed Rs. 12 lakh is eligible to claim a rebate under Section 87A, subject to the prescribed conditions. 

As a result, eligible taxpayers with income up to the specified threshold may claim a rebate of up to Rs. 60,000. However, in both such cases, a rebate cannot be claimed against income taxable at special rates (such as certain capital gains), as such income does not qualify for rebate benefits.

Should salaried employees reconsider their tax regime choice after receiving Form 16?

Salaried employees may consider revisiting their tax regime selection after receiving Form 16, particularly where the actual tax position differs from assumptions made earlier in the financial year. In many cases, employees opt for a tax regime at the beginning of the year based on estimated investments, exemptions and deductions. 

However, the final Form 16 issued by the employer reflects actual salary components, tax deducted at source (TDS), exemptions considered, deductions claimed through payroll and any changes in compensation structure during the year. As a result, the ultimate tax liability may vary from the initial estimate.

For taxpayers eligible to choose between the old and new tax regimes, receipt of Form 16 presents an opportunity to undertake a final comparative computation under both regimes before filing the income-tax return. 
 

Can taxpayers switch regimes every year, and how does this affect their tax planning strategy?

Deepashree Shetty, Partner, Global Mobility Services, Tax & Regulatory Advisory at BDO India, says that salaried taxpayers have the flexibility to switch between the old and new tax regimes every year. Hence, it is important to evaluate both options annually based on comparative tax liability. However, for business income, the regime selection is more restrictive and thus, long-term planning becomes essential.

What are the most common errors taxpayers make while claiming deductions and exemptions in their ITR?

“Common errors include claiming ineligible deductions, exceeding prescribed limits and mismatches with Form 16/AIS/26AS. Taxpayers also often rely on employer declarations without revisiting them at the filing stage, which can lead to incorrect claims and potential notices,” said Deepashree Shetty. 
 

How can taxpayers verify whether deductions and exemptions reflected in Form 16 have been correctly considered while filing ITR?

Taxpayers should not rely blindly on pre-filled ITR data. A thorough reconciliation of salary, exemptions/deductions and TDS between Form 16, AIS and Form 26AS is essential to ensure ITR filing accuracy and prevent future discrepancies.

What documents should taxpayers maintain to support deduction and exemption claims?

A critical aspect is to maintain a robust documentation trail, which includes investment proofs, insurance premium receipts, home loan statements, rent receipts, donation records, etc. These should be retained for any future verification or questioning by the tax authorities.

Source: Financial Express