What Is Marginal Tax Rate? A Simple Guide To How It Works
Marginal tax rate is the rate of tax that applies to the last rupee of income you earn. It helps the government collect tax based on how much a person earns. In India, the income tax system uses a progressive structure. This means that higher income gets taxed at higher rates.
Marginal Tax Rate Vs. Effective Tax Rate
Marginal tax rate is not the same as the effective tax rate. The marginal rate refers only to the rate applied to the highest income slab you fall under. The effective tax rate is the average rate you pay on your total income after deductions and exemptions.
Example
If your total income is ₹12 lakh in a financial year, you may fall into the 30% slab under the old regime. But not all your income is taxed at 30%. Only the income above ₹10 lakh gets taxed at 30%. The income between ₹5–10 lakh gets taxed at 20%, and ₹2.5–5 lakh at 5%. This structure defines the marginal tax system.
Why India Uses A Marginal Tax System
India uses a marginal tax system to keep taxation fair. People who earn more pay more tax. Those who earn less pay lower taxes. This structure helps reduce inequality. It also increases tax collection from those with higher incomes.
Income Tax Slabs In India (FY 2024–25)
India offers two tax regimes – the old regime and the new regime. Both follow the marginal tax structure but with different slab rates and benefits.
New Regime Slabs (Default Regime)
| Income range | Tax rate |
|---|---|
Up to ₹3,00,000 | 0% |
₹3,00,001 – ₹7,00,000 | 5% |
₹7,00,001 – ₹10,00,000 | 10% |
₹10,00,001 – ₹12,00,000 | 15% |
₹12,00,001 – ₹15,00,000 | 20% |
Above ₹15,00,001 | 30% |
Old Regime Slabs
| Income range | Tax rate |
|---|---|
Up to ₹2,50,000 | 0% |
₹2,50,001 – ₹5,00,000 | 5% |
₹5,00,001 – ₹10,00,000 | 20% |
Above ₹10,00,001 | 30% |
In both cases, the income is divided into slabs. Each slab is taxed at its own rate. This method helps apply marginal tax rates effectively.
How Marginal Tax Rate Works
Let’s look at an example for clarity. Say, a person earns ₹12,50,000 per year under the old tax regime.
Here’s how tax is calculated step-by-step:
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Income up to ₹2.5 lakh – No tax
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₹2.5 lakh – ₹5 lakh – 5% of ₹2.5 lakh = ₹12,500
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₹5 lakh – ₹10 lakh – 20% of ₹5 lakh = ₹1,00,000
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₹10 lakh – ₹12.5 lakh – 30% of ₹2.5 lakh = ₹75,000
Total Tax = ₹12,500 + ₹1,00,000 + ₹75,000 = ₹1,87,500
Here, the marginal tax rate is 30% because that is the rate applied to the last portion of income.
Why Marginal Tax Rate Matters
Understanding your marginal tax rate can help you make smarter financial decisions. Here’s why it matters:
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Financial planning: Knowing your marginal rate helps you estimate how much of your additional income, say from a bonus, freelance work, or investment, is likely to go in taxes. This helps you plan better for savings, investments, or expenses.
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Tax-saving strategies: Your marginal rate tells you how much tax you can potentially save if you use deductions or exemptions.
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Salary structuring: Knowing your marginal tax rate is useful while negotiating your salary package. You may prefer certain components, like reimbursements or retirement contributions, that are tax-efficient depending on your marginal tax bracket. It can also help you understand how bonuses or increments will be taxed.
Marginal Tax Rate For Businesses
For companies and Limited Liability Partnerships (LLPs), marginal tax rate works differently. Corporate tax rates in India are flat beyond a certain threshold. However, small companies and startups may benefit from lower rates if their income is below a limit.
Marginal Tax Rate For Senior Citizens
In the old tax regime, senior citizens (60 to 80 years) and super senior citizens (above 80 years) have higher exemption limits.
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Senior citizens: ₹3 lakh basic exemption
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Super senior citizens: ₹5 lakh basic exemption
The marginal tax rate starts after these thresholds, making their tax burden lighter.
How To Lower Your Marginal Tax Rate
You cannot change the slab rates, but you can reduce the income that falls in the higher slabs. You can consider the following methods:
If you are following the old tax regime, you can invest strategically to make use of tax deductions. This allows you to lower your taxable income, which in turn, helps avoid higher marginal tax slabs.
For instance, you can claim a deduction of up to ₹1.5 lakh by investing in Section 80C instruments such as the National Pension System (NPS), Employee Provident Fund (EPF), Public Provident Fund (PPF), Equity-Linked Savings Scheme (ELSS).
You can also claim a tax deduction under Section 80D for health insurance premiums. If you have a home loan, you can claim a deduction under Section 24(b) for the interest paid towards it up to ₹2 lakh in a given financial year.
Conclusion
Marginal tax rate is a key part of India’s income tax system. It ensures citizens pay taxes based on how much they earn. Only the portion of income that crosses a limit gets taxed at higher rates. This system keeps taxation fair and balanced. Knowing your marginal tax rate helps you save better, invest wisely, and plan smartly for the future.
FAQs
Does the marginal tax rate apply to income from all sources?
No, the marginal tax rate mainly applies to your total taxable income from salary, business, or other sources that fall under the regular slab system. Capital gains, dividend income, and lottery winnings often have fixed tax rates. These are taxed separately and do not follow the slab-wise marginal system.
Can a marginal tax rate change during a financial year?
Yes, if your income increases during the year, through a bonus, increment, or business profit, you may enter a higher slab. This change adjusts your marginal tax rate upward. However, it applies only to the income earned after crossing the new threshold.
Does filing under the new tax regime affect my marginal tax rate?
Yes, the new regime has different slab rates and changes how your income is taxed. It usually results in a lower marginal rate for most middle-income earners. However, it also removes common deductions, such as Section 80C, which may offset some benefits.
This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.
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