If you are a salaried person, you must first understand your obligations under the income tax act. As you might know, income tax is levied on individuals and companies based on their earnings or profits.
Firstly, you should familiarise yourself with the tax implications on salary earned and figure out how much is tax liability on salary earned. Then you must understand how to save tax on salary by claiming tax deductions under the applicable provisions of the income tax act.
Generally, individuals minimise their taxable income by investing in specific financial products that are part of section 80C. These products include life insurance premiums, EPF, PPF, NSC (National Savings Certificate) contributions, and investments in ELSS and NPS. However, there are some lesser-known tax deductions as well that can help you in saving money.
Understanding Tax Regimes:
Before we delve into understanding your salary components and ways of tax deduction, let us shed some light on the income tax slab and the two tax-regimes. In India, each individual has to pay taxes depending on their income. In other words, individuals with a higher income fall in the higher tax-slab rate and individuals with lower income have to pay lower taxes. This slab system was introduced to maintain a fair tax practice in the country.
Currently, there are two tax-regimes that individual tax-payers and Hindu Unified Families (HUF) can opt for:
- The old tax regime
- The new tax regime
These regimes have different tax rates for different income slabs.
While the old regime has higher tax-rates, it offers various tax deductions and exemptions that helps tax-payers to maintain their financial portfolio. You have the option to avail of tax deductions such as health insurance and ELSS investments under section 80 C, house rent allowance, etc.
On the other hand, the new tax regime offers lower tax rates and lesser complications thus putting more money in the hands of taxpayers. But there are no exemptions and deductions available under this tax regime, which will increase your total taxable income.
Let us take a look at Income Tax slab rates under both regimes:
|Income Tax Slabs (Rs.)||Old Tax Rates||New Tax Rates|
|0 – 2,50,000||0%||0%|
|2,50,000 – 5,00,000||5%||5%|
|5,00,000 – 7,50,000||20%||10%|
|7,50,000 – 10,00,000||20%||15%|
|10,00,000 – 12,50,000||30%||20%|
|12,50,000 – 15,00,000||30%||25%|
|15,00,000 & above||30%||30%|
Both the new and old income tax slabs have their benefits and drawbacks. Before making a choice, you should do a comparative analysis of both depending on your income.
Components of Salary Structure
Salary is one of the taxable earnings under the provisions of the Income Tax Act. Salary is not a lump sum single component amount. Instead, it is made up of several components. Some of these components are entirely taxed, some are taxed partially, while some are exempted from tax. It is easier for the taxpayer to carry out better tax planning if they understand the implications of each salary component. Also, to know how to save income tax, it is crucial to know the structure breakdown of the salary.
The basic salary component is the amount of money that an employee earns before extra payments are added or removed. It is a fixed portion of the wage that does not include bonuses, overtime pay or any other compensation from the employer. The basic wage is the foundation of the salary structure, accounting for 40-45% of the entire CTC (cost to company). The whole of your basic wage is included in the take-home pay, and it is fully taxable.
An allowance is a financial benefit you receive from your employer over and above your regular salary. Companies offer a variety of allowances, including dearness allowance (DA), house rent allowance (HRA), leave travel allowance (LTA), medical allowance and transport allowance. However, not every allowance is taxed equally under the income tax provisions.
Some allowances are taxed under the head salary making them fully-taxable such as Dearness Allowance, Entertainment Allowance, etc. Some allowances are exempted from tax to a certain limit, thus giving them the popular nomenclature ‘partially taxable’ allowances. These include House Rent Allowance, Special Allowance, Medical Allowance, etc. Lastly, there are non-taxable allowances that are fully exempted from taxes such as allowances paid to government employees abroad, allowances paid to UNO employees, and more.
Dearness allowance (DA)
It is an allowance for the cost of living to help people cope with the effects of inflation. It is fully taxable and computed as a percentage of basic salary.
House rent allowance (HRA)
House Rent Allowance is given by an employer as an allowance for the house rent you pay. The portion of your salary that you receive as HRA is allowed for tax deduction under Section 10(13A). The deduction is available on the least of the following amounts:
- Actual HRA that your employer provides
- 50% of [basic salary + DA] if you live in a metro city
- 40% of [basic salary + DA] if you live in a non-metro city
- Your rent should be less than 10% of basic salary + DA
Leave travel allowance
It is the expense of an employee’s solo or family trip to any location in India. Tax exemption in LTA is based on the following criteria
- The LTA exemption is restricted to travel expenditures and does not apply to accommodation and food.
- LTA exemption can only be availed for two journeys in a block of 4 years.
- Travel must be done within India.
It is a fixed allowance granted to employees and their families to cover medical expenses. It is fully taxable under the provisions. Please note that medical allowance is different from medical reimbursement.
Allowance paid to meet the transport expenses. It is partially taxable, and the exemption is restricted to Rs1,600 per month or Rs 19,200 per year. Any excess transportation allowance is taxed.
5 Uncommon Tax Deductions
Let’s assume you have chosen the old tax regime and are looking for ways for tax deductions. Here is a list of five unconventional deductions you can claim:
You are eligible for tax deductions if you take a home loan to buy or build a house. In the case of constructing a house, the building must be finished within 5 years. The tax deduction on a housing loan is available on two components –
- Interest payment
- Principal repayment
For the interest portion of your EMI, you can claim up to Rs.2 lakh tax deduction under Section 24. In case the house is under construction, the benefit of interest deduction is not available unless the construction is completed.
Further, under Section 80C, the principal portion of the EMI is allowed as a tax deduction, with a maximum limit of Rs. 1.5 lakh. You can also claim the registration and stamp duty fees as part of this amount. However, suppose you sell this house property within five years of possession. In that case, the claimed deduction will be added back to your income.
Moreover, there are additional provisions for taking a loan jointly. Firstly, both the loan holders can claim a maximum deduction of Rs 2 lakh each on interest. Other than that, they can also claim a deduction of Rs 1.5 lakh each for principal repayment.
Leave travel allowance
While LTA is an effective measure to reduce your taxable income, you should be aware of the variables under LTA exemption. Firstly, the LTA amount is exempted only for two years in a block of four years. The exemption only applies to travel costs, such as plane or railway fares. The amount eligible for exemption will be limited to 1st class rail fare and the shortest route applicable to destination.
The LTA exemption does not apply to additional expenses like local transportation, accommodations, food, etc.
An added advantage of the LTA exemption is that it can be claimed not only for self but also for family members. This includes your spouse, children, dependent parents or siblings.
Donate and earn
Contributions to certain relief funds and charitable institutions are deductible under Section 80G of the Income Tax Act. However, all donations are not eligible for these deductions. Only contributions to specific funds are deductible.
This deduction is available to all taxpayers, including individuals, corporations, partnerships, and sole proprietorships, who have contributed via a cheque, draft, or cash.
Pay for Parents’ Health and Health Insurance
Under Section 80D, you can claim a deduction for paying the health insurance premium for yourself and your family. You can claim Rs.25,000 on the premium paid if your parents are up to 60 years old. And if they are above 60, you can claim up to Rs.50,000 on their health insurance premium payment.
Additionally, suppose your parents are senior citizens and do not have any insurance policy. In that case, you can claim a deduction of up to Rs. 50,000 yearly for the medical expenditure.
Contributions to a political party
Political contributions are paid to cover the expenses incurred by political parties during election campaigns. Indian companies and individuals are allowed to make donations to political parties approved by the Election Commission of India. These donations should be through cheques, net banking, or UPI to qualify for deductions under section 80GGC for individuals and 80GGB for companies. In case of individuals, the quantum of contribution is restricted to a maximum of 10% of their Gross Total Income.
Under the Income Tax Act of 1961, there are numerous lawful ways for taxpayers to save tax on salary. These include ELSS mutual funds, NPS, insurance premiums, medical insurance, and various other tax-saving instruments. However, you should retain expenditure documentation as proof to ensure seamless processing of these deductions.
FAQs to save tax on your salary
How is DA determined in the base salary?
A dearness allowance is a fixed percentage of the basic salary, helping employees to hedge inflation. As it is directly related to the cost of living, it varies depending on the employee’s location. In other words, DA is different for employees in a metro city, semi-urban sector and rural area.
Can I claim an HRA tax exemption if I am paying rent to my family?
Yes, house rent paid to family members, including parents, can be claimed as an HRA deduction. You just need to have valid proof of payment. However, if you are paying rent to a spouse it is not eligible for deduction.
Is tax deducted from my paycheck every month?
Every month, your employer deducts a portion of your salary and pays it to the Income Tax Department on your behalf. Even though income tax is paid monthly from monthly earnings, it is calculated annually.
Do I need to file an Income Tax Return (ITR) if my annual income is below ₹2.5 lakh?
If your income is below ₹2.5 lakh, you are not required to file Income Tax Returns (ITR) under the old as well as new tax regime. However, filing your ITR is beneficial in the long run as it is needed for your loan application and visa process.