How to Calculate Income Tax on Salary: Allowances & Deductions
While the Indian Government’s website offers an online calculator where people can calculate tax online, knowing how to calculate it manually is important. It helps understand what part of a salary is taxable and what is exempt. Also, the assessee can claim the deduction allowed under the Income Tax Act to reduce the taxable income further.
Details of calculating income tax on salary, considerations taken under it, applicable tax slab, allowances, and deductions are mentioned below. It applies to all employees, i.e., individuals working as salaried employees in a corporation or organisation.
What Is Income from Salary?
Income from salary is the compensation employees receive in return for the service provided. The income tax department counts it as ‘income from salary’ only if the relationship between the payer and receiver is an employer and employee. Typically, it includes basic salary, allowance, commission, bonus, and fees. Further classification is mentioned.
Terms to Know While Calculating Income Tax
Below are a few basic terminologies individuals use while calculating income tax:
- Tax Year
The tax year or financial year is the year for which the assessee calculates tax. This period starts on April 1 and ends next year on March 31. So, while calculating income tax on salary, one needs to take the total salary earned during this period.
- Assessment Year
The assessment year is different from the financial year. It is the year that comes after the financial year. So, if you need to calculate the tax for 2021-22, its assessment year will be 2022-23.
- Salary Breakup
Salary breakup is another important component you must know about to calculate the right income tax on salary. Employees can find it in detail in their salary slips, containing information on HRA, DA, PF, etc.
- Taxable Income
Taxable income is the amount on which an individual needs to pay tax. It does not only include income from salary but many other mediums like income from property, income from gain, income from other sources, and income from business or profession.
The deduction is an expense that can be subtracted from your taxable income to reduce the tax liability. Deductions are mainly available under Section 80 to promote savings and other specific expenditures among individuals.
What Are the Taxable Heads under Salaried Income?
Several components in an individual’s salary are taxable – some fully taxable and some partly taxable. Here’s a list of all the taxable heads in your salaried income.
Examples of fully taxable allowances are
- Dearness allowance
- Deputation allowance
- Servant allowance
- City compensatory allowance
- Overtime allowances
Examples of partly taxable allowances are
- House rent allowances
- Entertainment allowances
- Children’s education allowances
- Travel or research allowances
How to Calculate Income Tax?
Along with the basic salary, income from salary includes transport allowance, house rent allowance and other allowances. Let’s understand the process of calculating income tax for a salaried individual with the help of the following steps.
Step 1: Calculate the Gross Salary
Gross Salary is the amalgamation of basic salary, house rent allowance, special allowance, transport allowance and other special allowances. At this step, if the standard deduction is available, it will also be deducted.
Step 2: Deduct the Tax Exemptions
Deduct the various exemptions and standard deductions, whichever is applicable. This will be the taxable income.
Step 3: Choose a Tax Regime (Old/New)
Calculate the income tax to be payable on this taxable income as per the available slabs. Here are the tax slabs mentioned below:
Old Tax Regime
|Income Tax Slab||Tax Rate|
|Up to ₹2,50,000||Nil|
|₹2,50,001 – Rs. 5,00,000||5% above ₹2,50,000|
|₹5,00,001 – ₹10,00,000||₹12,500 + 20% above ₹5,00,000|
|Above ₹10,00,000||₹1,12,500 + 30% above ₹10,00,000|
New Tax Regime u/s 115BAC
|Income Tax Slab||Tax Rate|
|Up to ₹ 2.5 Lakh||Nil|
|₹ 2.5 Lakh to ₹ 5 Lakh||5% above ₹ 5 Lakh|
|₹ 5 Lakh to ₹ 7.5 Lakh||₹ 12,500 + 10% above ₹ 5,00,000|
|₹ 7.5 Lakh to ₹ 10 Lakh||₹ 37,500 + 15% above ₹ 7,50,000|
|₹ 10 Lakh to ₹ 12.50 Lakh||₹ 75,000 + 20% above ₹ 10,00,000|
|₹ 12.50 Lakh to ₹ 15 Lakh||₹ 1,25,000 + 25% above ₹ 12,50,000|
|More than ₹ 15 Lakh||₹ 1,87,500 + 30% above ₹ 15,00,000|
Step 4: Derive the Net Salary
In this step, the income tax derived along with the provident fund will be excluded from the taxable income to derive the net salary.
Exemptions Allowed While Computing Income Tax from Salary
Salaried individuals are eligible for exemptions on the income tax, which helps them legally save tax which in turn assists in reducing the tax burden. Here are various crucial income tax exemptions for the salaried individual listed below:
- House rent allowance
House Rent Allowance (HRA) exemption is a pivotal tax exemption as it is easy to claim while computing the income tax on salary. Many companies and firms offer a large amount of HRA to their employees to meet all expenses related to accommodation rent.
As per section 10(13A), a portion of the house rent allowance is exempted from tax. The amount of house rent allowance granted to an employee depends on factors like salary, rent paid, place of accommodation, and the amount of HRA received.
How Is HRA calculated?
The calculation of HRA is understood with the help of an example following the steps below.
Step 1: Consider the total salary.
For example, let an individual’s compensation be ₹50,000, including an HRA of ₹ 24,000. For easy understanding, let’s assume he pays ₹ 2,000 per month or ₹24,000 per year as rent in a Metro City.
The calculation of the tax exemption applicable in this case is elaborated in the next step.
Step 2: Calculate the exemption amount.
The least of any of the following three amounts will be considered for exemption.
|Actual HRA received for a year (For example, ₹ 2000 X 12)||₹24,000|
|Rent paid – 10% of salary (₹24,000 – ₹5,000)||₹19,000|
|50% of the salary||₹25,000|
Step 3: Calculate the HRA
An amount of ₹19,000 will be exempted as House Rent Allowance (HRA), and
the amount of ₹5,000 will be included in the gross salary of the employee.
- Leave travel allowance
When employees go on a vacation, accompanying their family, many companies offer Leave Travel Allowance (LTA) for expenses incurred on vacation. The employee claims this Leave Travel Allowance by submitting all actual bills of the staycation.
An employer grants the amount of leave travel concession based on which designation that employee is in. The computation of this allowance is made at the time of filing an income tax return, and exemption is available under section 10(5).
- Encashment of leaves for salaried employees
In all organisations, a certain number of leaves are allotted to employees. If an employee does not apply for these leaves in a financial year, some companies allow these employees to encash these leaves in terms of cash. This amount received as leave encashment is eligible for exemptions if received at the time of retirement/resignation for Central or State Government employees. However, it is taxable for a non-government employee.
- Pension income
A pension scheme is available to employees in most services once they retire. Pension in an organisation can be of two types which are commuted and uncommuted. An employee is said to receive a commuted pension when the whole pension is in a lump sum.
In the case of an uncommuted pension, an employer pays the pension in instalments for a consecutive period.
- Gratuity for salaried employees
Income tax exemptions is also available on an employer’s gratuity as a token of appreciation for the services rendered by the employee in that organisation. Generally, gratuity is received in two different ways –
- Directly to an employee during their retirement.
- To the family of an employee at the time of his death.
To make a computation of exemptions on Income tax on salary easy, allowance of exemptions is available in three different parts:
- Employees who fall under the Payment of Gratuity Act of 1972.
- Applicable to Government employees and Local Authorities.
- Applicable to employees not covered in any of the above two factors.
- VRS amount received
There are employees in every organisation that opts for Voluntary Retirement before attaining 60 years. In these cases, the employer offers a lump-sum amount of money on the occasion of his voluntary retirement. As per Section 10(10C), the amount receivable by the employee during his/her voluntary retirement under the golden handshake scheme is exempted.
In addition to all the above exemptions, employers offer different perquisites like mobile phones, cars, etc. Furthermore, other exemptions, like children’s education allowances, transport allowances, etc., act as an allowance while computing income tax for salaried individuals.
Deductions on Income Tax Available to Salaried Individuals
The income tax for salaried individuals has been prescribed in a way that allows relaxation from bearing excessive tax burden. Apart from the standard deductions of ₹50,000, available to all taxpayers, several other deductions are available to salaried employees.
Here are some of the pivotal deductions available to salaried individuals:
- Section 80C
The deductions under Section 80C, 80CCC, and 80CCD are one of the crucial ways to help reduce salaried individuals’ tax burden. Deduction of up to ₹1.5 lakh is available in one financial year on the following heads:
- Public Provident Fund (PPF).
- Employees’ Provident Fund (EPF).
- Life Insurance Premiums.
- National Savings Certificates.
- Term deposits which are not less than 5 years.
- Equity Linked Saving Scheme and a few others.
- Section 80D
Under Section 80D, a deduction on income tax on salaried employees is available in medical insurance. A taxpayer is eligible for a deduction of a maximum of ₹25,000, which he is paying as a health insurance premium for himself or any of his family members or dependents. In addition, as per the provisions in the section, if a taxpayer is paying premiums for a policy of his/her parents (senior citizen), then the amount of ₹50,000 will be available for deduction.
- Section 80E
Any loan taken as an educational loan for himself or his spouse from a banking institution will be eligible for deductions under section 80E under the Income Tax Act.
- Section 80G
The deduction in Section 80G is related to the donations that are made to registered charitable organisations. This also includes trusts and other approved funds, etc. and deduction is available for up to 50% to 100%. Being one of the popular deductions, the provisions under this section offer maximum tax relief.
- Section 80TTA
Deduction Under Section 80TTA, an assessee can claim deductions on the income generated from the savings account. The claim on the deduction is available up to a maximum amount of ₹10,000.
- Section 24B
Section 24B of the Income Tax Act, 1961 states that interest on a home loan for purchasing a home or for construction and repair purposes is eligible for deduction. Moreover, this deduction is available on an accrual basis, meaning the interest payable for a year is eligible for deductions. This relaxation is available in two or more housing loans or houses.
Understand with an Example
Income from salary is the sum-total of basic salary, house rent allowance, special allowance, transport allowance and other allowances. Calculating tax on this salary income is explained with an example below. However, you can also use the income tax calculator 2022-23 online.
Here we calculate income tax on Neha’s FY 2022-23 salary. The details required for calculation are as below:
Basic Salary: ₹ 1 lakh per month
HRA: ₹ 40,000 per month
Special Allowance: ₹ 20,000 per month
Leave Travel Allowance: ₹ 20,000 in a year
Investment in Notified Pension Scheme: ₹ 10,000
|Particulars||Amount in ₹|
|Leave Travel Allowance||20,000|
|Gross Total Income from Salary||19,40,000|
|Investment in NPS u/s 80 CCD (2)||(10,000)|
Under the new tax regime, she will fall under the tax slab of 15 lakhs and above.
So taxes payable will be ₹ 1,87,500 + 30% above ₹ 15,00,000. So it is ₹ 1,87,500 + ₹ 1,29,000 = ₹ 3,16,500. On top of that, we have to add a 4% sess on the income tax amount. So, the total tax liability of Neha will be ₹ 3,29,160.
Here we have taken an example to calculate taxes on your salary. If you have any source of income other than salary, then you need to disclose it and add that income to the calculation of the gross taxable income.
For proper tax calculation, taxpayers must correctly declare income from all sources, investments made, and expenses paid. Also, one can find the process of how calculating income tax on salary fixed under the Income Tax Act above. It is important to follow the correct process because assessees can attract penalties and imprisonment if found hiding income and evading taxes.
Frequently Asked Questions
Are retirement benefits like Provident Funds and Gratuity taxable?
Employees of non-government organisations are eligible for exemption on gratuity to a prescribed limit which is ₹20 lakh, as per the new tax regime. Whereas, in the case of provident fund (PF), the exemption on the receipt is available if the employee was under the employment for not less than 5 years.
However, in the case of a Government employee, the full exemption is available on the PF and gratuity receipt.
What is the available relief U/S89?
Under section 89, relief is available to individuals if they have received any of the following:
1. Compensation received for termination of employment as per Rule 21A(4).
2. Commuted pension received in excess of exemption under Section 10(10A)(i) as per Rule 21A(5).
3. Salary or family pension received in arrears or in advance as per Rule 21A (2).
4. Gratuity received in excess of exemption under Section 10(10)(ii)(iii) as per Rule 21A(3).
What Exemptions and deductions are not allowed under the new tax regime?
Except for deduction u/s 80CCD (2), which will be applicable for New Tax Regime, almost all other exemptions and deductions, including Section 80C, are not allowed in the new tax regime.
What happens if you do not file your income tax return?
If you do not file your income tax return within the last filing date, the IT department will send you a notice and charge interest until you pay the tax amount. Also, you will not receive any refund for filing a belated return. Moreover, it should be within the specified period.