Strategic Income Allocation & Clubbing Rules under the New Regime for Couples

Beyond Deductions: Strategic Income Allocation & Clubbing Rules for Couples in the New Tax Regime The New Tax Regime, now the default ch...

Beyond Deductions: Strategic Income Allocation & Clubbing Rules for Couples in the New Tax Regime

The New Tax Regime, now the default choice from FY 2024-25 (AY 2025-26) onwards, has simplified income tax by largely eliminating common deductions. For salaried individuals, the effective tax-free income can go up to ₹7.5 lakh in FY 2024-25, and potentially up to ₹12.75 lakh in FY 2025-26 with the increased standard deduction and rebate under Section 87A.

While this promises ease, for married couples, strategic financial planning remains crucial. India's individual taxation system, coupled with the ever-present "clubbing of income" rules, means that simply adopting the new regime without understanding its nuances could lead to unexpected tax liabilities. This comprehensive guide will demystify income clubbing, explore its implications under the new tax regime, and provide actionable strategies for couples to optimize their finances, drawing comparisons with the old regime for context.

The Fundamental: Individual Taxation in India

Before diving into allocation strategies, it's vital to remember that India follows an individual taxation system. Unlike some countries where married couples can file joint tax returns, in India, each spouse is considered a separate taxpayer with their own PAN and is required to file their own Income Tax Return (ITR).

This individual assessment is the foundation upon which all income allocation and clubbing rules are built. Even with the New Tax Regime's higher basic exemption limits, these apply to each individual taxpayer separately.

Understanding "Clubbing of Income" (Section 64 of the Income Tax Act, 1961)

The concept of "clubbing of income" is the Income Tax Department's way of preventing individuals from artificially reducing their tax liability by diverting income to family members who might be in lower tax brackets or have no income at all. Essentially, if certain conditions are met, income earned by one person (e.g., your spouse or minor child) might be "clubbed" or added back to your income for tax calculation purposes.

Why is Clubbing Important, Especially in the New Regime?

In the Old Tax Regime, with numerous deductions and exemptions available (like Section 80C, 80D, HRA exemption, Section 24(b) for home loan interest), couples had many avenues to save tax. Strategic income allocation often involved maximizing these deductions individually.

However, the New Tax Regime largely strips away these deductions. This means that direct tax-saving through investments is significantly reduced. In this scenario, the importance of understanding clubbing provisions heightens, as any attempt to shift income without legitimate reason can backfire, leading to unexpected tax liabilities. With fewer ways to reduce taxable income, the taxman is more vigilant about artificial income diversion.

New Tax Regime: Key Features for Salaried Individuals (FY 2024-25 & FY 2025-26)

Let's first clarify the new regime's basic structure, which impacts how individual income is assessed.

New Tax Regime Slab Rates for Individuals (FY 2024-25 / AY 2025-26)

Income Slab (₹)	Tax Rate (%)
Up to 3,00,000	Nil
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 15,00,000	30%

• Rebate u/s 87A: Full tax rebate up to ₹25,000 for taxable income up to ₹7,00,000.

• Standard Deduction: ₹50,000 for salaried individuals and pensioners.

• Effective Tax-Free Income for Salaried: Up to ₹7,50,000 (₹7,00,000 + ₹50,000 standard deduction).

New Tax Regime Slab Rates for Individuals (Proposed for FY 2025-26 / AY 2026-27 onwards)

Income Slab (₹)	Tax Rate (%)
Up to 4,00,000	Nil
4,00,001 - 8,00,000	5%
8,00,001 - 12,00,000	10%
12,00,001 - 16,00,000	15%
16,00,001 - 20,00,000	20%
20,00,001 - 24,00,000	25%
Above 24,00,000	30%

• Rebate u/s 87A: Increased to ₹60,000, making taxable income up to ₹12,00,000 effectively tax-free.

• Standard Deduction: Increased to ₹75,000 for salaried individuals and pensioners.

• Effective Tax-Free Income for Salaried: Up to ₹12,75,000 (₹12,00,000 + ₹75,000 standard deduction).

Common Scenarios Leading to Clubbing of Income (with Examples):

Let's explore the key scenarios where income clubbing provisions come into play, keeping the New Tax Regime's context in mind:

Gifts to Spouse Without Adequate Consideration [Section 64(1)(iv)]

• The Rule: If an individual transfers any asset (other than house property, which has specific provisions) to their spouse, either directly or indirectly, without "adequate consideration" (i.e., for free or for a nominal amount), any income arising from that asset will be clubbed with the income of the transferor (the person who made the gift).

• New Regime Impact: While gifts received on the occasion of marriage are tax-free for the recipient, any income subsequently generated from such gifted assets (if not for adequate consideration) will still be clubbed back to the donor. This means the higher effective tax-free limits of the New Regime won't apply to the spouse on this specific income; it will be added to the donor's income and taxed at their applicable New Regime rates.

• Old Regime Contrast: The rule itself is the same. However, in the old regime, the receiving spouse might have been able to claim deductions (e.g., if the gifted money was used to purchase an 80C investment) against other income they earned, potentially reducing the overall family tax burden. In the New Regime, such deductions are largely absent, making the clubbing impact more direct.

• Example 1: Gifted Fixed Deposit Interest

• Scenario: Mr. Sharma gifts ₹8 lakh to Mrs. Sharma (without adequate consideration). Mrs. Sharma invests this entire amount in a Fixed Deposit (FD) earning 7% interest annually, which is ₹56,000.

• New Regime Impact: This ₹56,000 interest income will be clubbed with Mr. Sharma's income. If Mr. Sharma's income is already in the 10% or 15% slab, this additional income will be taxed at that rate. Mrs. Sharma cannot claim any deduction against this income in the new regime.

• Old Regime Contrast: Same clubbing. If Mrs. Sharma had other income, she could have claimed Section 80C deductions if she invested in tax-saving instruments, potentially reducing her overall tax. In the new regime, this option is absent for the clubbed income.

• Exceptions (Where Clubbing Does Not Apply):

• Adequate Consideration: If the asset is transferred for fair market value.

• Agreement to Live Apart: If the transfer is made under an agreement to live separately.

• Prior to Marriage: Gifts made before marriage are not subject to clubbing once the couple is married.

• Income from Income (Second-level Income): This is a crucial exception. If the income that was initially clubbed (e.g., the ₹56,000 interest in Example 1) is reinvested by the spouse, any further income generated from this reinvestment will not be clubbed. It will be taxed in the spouse's hands. This offers a limited but legal avenue for couples.

• Example 2: Second-Level Income: In Example 1, if Mrs. Sharma takes the ₹56,000 interest and reinvests it to earn another ₹3,000, this ₹3,000 will be taxed in Mrs. Sharma's hands and will not be clubbed with Mr. Sharma's income.

Remuneration to Spouse from a Concern where the Other Spouse has a Substantial Interest [Section 64(1)(ii)]

• The Rule: If your spouse receives a salary, commission, fees, or any other remuneration from a concern (e.g., a company or firm) in which you have a "substantial interest," such remuneration will be clubbed with your income.

• "Substantial Interest": This means holding 20% or more of the voting power (in a company) or 20% or more of the profits (in a firm/LLP).

• New Regime Impact: This rule prevents diverting income through fictitious employment. The higher effective tax-free limits in the new regime don't negate this. If clubbing applies, the spouse's salary will be added to your income, and you'll be taxed on the combined amount at your applicable new regime rates.

• Old Regime Contrast: The principle is identical. The only difference would be in the tax rates and the availability of deductions.

• Example 3: Spouse's Salary Clubbing

• Scenario: Mrs. Priya owns 25% shares in ABC Pvt. Ltd. (a substantial interest). Her husband, Mr. Raj, is employed as a 'Manager - Operations' in ABC Pvt. Ltd., drawing a salary of ₹60,000 per month (₹7.2 lakh per annum). Mr. Raj has no formal management degree or prior experience in operations.

• New Regime Impact: Since Mr. Raj lacks relevant professional qualifications and experience for the role, his annual salary of ₹7.2 lakh will be clubbed with Mrs. Priya's income. Even though Mr. Raj's income is within the ₹7.5 lakh effective tax-free limit for salaried individuals (FY 2024-25), it won't benefit him individually but will inflate Mrs. Priya's taxable income.

• Exception: This clubbing provision does not apply if the spouse possesses professional or technical qualifications relevant to the nature of the employment, and the remuneration is solely attributable to their application of such qualifications.

• Example 4: No Clubbing due to Qualification: If, in Example 3, Mr. Raj holds an MBA in Operations Management and has 10 years of relevant experience before joining ABC Pvt. Ltd., his salary would likely not be clubbed with Mrs. Priya's income, as it's genuinely earned due to his qualifications.

Income of a Minor Child [Section 64(1A)]

• The Rule: All income arising or accruing to a minor child (below 18 years of age) is generally clubbed with the income of the parent whose total income (excluding the minor's income) is greater. If parents are divorced or separated, it's clubbed with the income of the parent who maintains the child.

• New Regime Impact: The higher effective tax-free limits for individuals in the new regime do not extend to minor children's unearned income. Any such income will be added to the higher-earning parent's income and taxed at their applicable new regime rates.

• Old Regime Contrast: Identical rule. However, a small exemption of ₹1,500 per minor child per annum is available under Section 10(32) for the clubbed income, which is available in both regimes.

• Example 5: Minor's FD Interest

• Scenario: Mr. and Mrs. Kumar have a minor daughter. Mr. Kumar deposits ₹2 lakh in an FD in his daughter's name. The FD earns ₹14,000 in interest annually. Mr. Kumar earns ₹20 lakh per annum, and Mrs. Kumar earns ₹10 lakh per annum.

• New Regime Impact: The ₹14,000 interest income will be clubbed with Mr. Kumar's income (as he is the higher-earning parent). After a ₹1,500 exemption, ₹12,500 will be added to his taxable income and taxed at his slab rate (likely 30% or higher).

• Important Exceptions:

• Income from Manual Work or Skill/Talent: Income earned by a minor child through their own manual work, or through the application of their skill, talent, or specialized knowledge (e.g., a child artist, sportsperson, or a child prodigy) is not clubbed. This income is taxed in the minor's hands directly.

• Example 6: Child Artist's Income: A minor child earns ₹5 lakh from acting in a TV show. This income is genuinely earned through their talent and will be taxed in the minor's hands.

Strategic Income Allocation for Couples in the New Regime:

Given the stricter "no deductions" approach of the New Tax Regime, strategic income allocation shifts from claiming deductions to ensuring income is genuinely earned by the individual liable to pay tax.

1. Leverage Individual Tax-Free Limits:

• Each salaried spouse can independently benefit from the effective tax-free income thresholds (₹7.5 lakh in FY 2024-25, and ₹12.75 lakh in FY 2025-26 including standard deduction).

• The goal is to ensure each spouse maximizes their own individual tax-free limit. If one spouse has income significantly below this, and the other above, look for legitimate ways to ensure income is generated in the hands of the lower-earning spouse.

2. Focus on Genuine Income Generation by Each Spouse:

• Independent Professional/Business Income: If both spouses are professionals (e.g., one a salaried employee, the other a freelancer or consultant), ensure genuine contracts and proof of work for the independent spouse. Their professional income will be taxed in their own hands, benefiting from their individual new regime slabs.

• Example: Mrs. Singh, a salaried professional, earns ₹15 lakh. Her husband, Mr. Singh, is a freelance graphic designer earning ₹6 lakh. In the new regime, Mr. Singh's income will be tax-free (FY 2024-25 effective limit ₹7.5 lakh). This is a clear benefit of individual taxation, not clubbing.

• Investment Income from Independently Acquired Funds: If a spouse has their own independent sources of funds (e.g., inherited money, past savings, or income from a profession/business), any income generated from investments made with these funds will be taxed in their hands and will not be clubbed.

3. Rental Income from Jointly Owned Property (and the Section 24(a) Standard Deduction):

• If you jointly own a let-out property, the rental income will be split as per your ownership share.

• Each co-owner can claim the 30% standard deduction under Section 24(a) on their respective share of the Net Annual Value (NAV). This deduction is allowed even in the New Tax Regime.

• Crucial Caveat: In the New Tax Regime, you cannot claim a deduction for interest on housing loan for self-occupied property. For let-out property, the interest can only be deducted against the rental income itself, and any loss cannot be set off against other heads of income (like salary or business income). This is a significant change from the Old Regime where such losses (up to ₹2 lakh) could be set off.

• Example: Jointly Owned Let-Out Property

• Scenario: Mr. and Mrs. Das jointly own a property (50:50 share) which is let out for ₹50,000 per month (₹6 lakh annually).

• New Regime Impact:

• Gross Annual Value: ₹6,00,000

• Less: Standard Deduction @ 30%: ₹1,80,000

• Net Annual Value (NAV): ₹4,20,000

• Each spouse's share of NAV: ₹2,10,000. This will be added to their respective incomes and taxed as per the New Regime slabs. The 30% standard deduction applies.

• Old Regime Contrast: Similar treatment for the 30% standard deduction. However, in the old regime, any interest paid on a home loan for this property could also be fully deducted from the rental income, and if it resulted in a loss, that loss could be set off against other income up to ₹2 lakh.

4. Employer's Contribution to NPS (Section 80CCD(2)):

• This is one of the very few deductions still available in the New Tax Regime. An employer's contribution to an employee's NPS account (up to 10% of Basic + DA, or 14% for Central Government employees) is deductible.

• Couples where both are salaried can leverage this benefit individually, reducing their taxable income even under the new regime.

• Example: Maximizing NPS Benefit

• Scenario: Mr. Arora has a Basic+DA of ₹10 lakh. His employer contributes 10% of his Basic+DA to NPS. Mrs. Arora has Basic+DA of ₹8 lakh, and her employer also contributes 10%.

• New Regime Impact: Mr. Arora can claim a deduction of ₹1 lakh (10% of ₹10 lakh) and Mrs. Arora can claim ₹80,000 (10% of ₹8 lakh) under Section 80CCD(2) even if they opt for the New Tax Regime. This reduces their respective taxable incomes.

5. Second-Level Income from Gifted Assets:

• As mentioned earlier, if income from a gifted asset is clubbed with your income, but your spouse reinvests that clubbed income, any subsequent income generated from that reinvestment is not clubbed. This can be a smart strategy to build independent wealth for the spouse over time, with the second-level income being taxed in their hands at their individual new regime rates.

• Example: Reinvestment of Clubbed Income

• Scenario: Mr. Singh gifts ₹10 lakh to Mrs. Singh. This is invested in an FD, earning ₹70,000 interest, which is clubbed with Mr. Singh's income. Mrs. Singh then uses this ₹70,000 (after Mr. Singh has paid tax on it) to buy shares. She earns ₹10,000 profit from these shares.

• New Regime Impact: The initial ₹70,000 is clubbed. However, the subsequent ₹10,000 profit from shares, derived from the reinvested clubbed income, will be taxed in Mrs. Singh's hands.

Comparing Old vs. New Regime for Couples (The Annual Choice)

While the New Tax Regime is the default, individuals without business or professional income have the option to switch to the Old Tax Regime annually. This choice is individual, and it's essential for couples to evaluate which regime benefits each spouse more.

Factors to Consider for Each Spouse:

Feature	Old Tax Regime	New Tax Regime	Implication for Couples
Tax Slabs	Higher rates but with numerous exemptions.	Lower rates at various income levels. <br> Effective tax-free income (Salaried): ₹7.5 lakh (FY 24-25), ₹12.75 lakh (FY 25-26 onwards).	Each spouse evaluates their own income to see which slab structure is more beneficial.
Deductions	Allowed: 80C, 80D, HRA, LTA, Section 24(b) (Home Loan Interest), etc.	Largely Disallowed: Most deductions (80C, 80D, HRA, Section 24(b) for self-occupied home loan interest) are not available. <br> Allowed: Standard Deduction (₹50K in FY 24-25; ₹75K in FY 25-26), Employer's NPS Contribution (80CCD(2)), Family Pension Deduction.	A critical decision point. If one spouse has significant existing deductions (e.g., a large home loan), the Old Regime might still be better for them.
Standard Deduction	₹50,000 for salaried/pensioners.	₹50,000 for salaried/pensioners (FY 24-25); ₹75,000 for salaried/pensioners (FY 25-26 onwards).	This benefit is available to each salaried spouse independently.
Complexity	Higher paperwork, more record-keeping.	Simpler, less documentation required.	New regime reduces compliance burden for couples.
Housing Loan Interest	Interest on self-occupied property up to ₹2 lakh deductible. Loss from house property can be set off.	No deduction for interest on self-occupied property. Loss from house property cannot be set off against other heads of income. Interest on let-out property can be deducted only from rental income.	Major impact for couples with joint home loans. If one spouse needs this deduction, they might opt for the Old Regime.
Annual Choice	Yes, can opt annually (for those without business/professional income).	Yes, can opt annually (for those without business/professional income).	Couples can split choices: one spouse chooses old, the other new, based on individual benefits.

Conclusion

The New Tax Regime represents a significant shift in India's tax landscape, emphasizing lower rates over deductions. For married couples, while the promise of simplicity is attractive, the enduring "clubbing of income" rules mean that strategic financial planning remains indispensable.

By understanding how assets and income transferred between spouses and minor children are treated, and by leveraging genuine income generation avenues, couples can still optimize their tax positions. The key is to move beyond the traditional deduction-focused mindset and embrace transparency and legitimate income streams. Remember, tax planning is an individual exercise, and often, what's best for one spouse might not be ideal for the other. A careful comparative analysis each year, taking into account individual income, expenses, and asset ownership, is paramount.