Section 16 of the Income Tax Act: Allowances and Deductions from Salary
Are you worried that you are paying more taxes than you ought to? Perhaps you have heavy medical bills and are afraid that tax will eat into your hard-earned income. If yes, we have few answers for you. This article outlines Section 16 of the Income Tax Act of 1961, which deals with tax deductions and allowances. You will find out what Section 16 of the Income Tax Act entails, what deductions and allowances you can claim, and more.
About Section 16
Section 16 of the IT Act is a provision in the Indian taxation system that deals with deductions and allowances. This section sets out specific components that can be deducted from taxable income and the limits on those deductions.
When filing your income tax, it is important to consider all relevant factors. Comprehending the provisions of Section 16 is essential to minimise the amount of taxes to be paid.
The objectives of Section 16 are twofold:
- To provide relief to taxpayers by reducing their taxable income, and
- To ensure that the tax base is broadened by including all income sources in the tax net.
Key Features of the Tax Provision under Section 16
The deductions outlined under Section 16 are as follows:
1. Standard deductions
2. Expenditure for entertainment paid by the employer (only for Government employee)
3. Professional Tax (Tax on employment)
Section 16(i)/(a): Standard Deduction
To determine the deductible amount under the head ‘Salaries,’ you must subtract these sums from the total payment received in a financial year:
- Amount of the salary or
- The standard deduction of ₹50,000, whichever is lower.
Section 16(ii): Allowance for entertainment
The entertainment allowance is initially included in the salary income under the heading ‘Salaries,’ and a further deduction can be requested on the grounds listed below:
In the case of a government worker (i.e., a state or central government employee), the minimum of the following amounts is subtracted:
- 20% of the basic wage
- Amount of entertainment allowance received
If the employee is a non-government employee (including those working for local governments and statutory corporations), he is not eligible for this deduction
The following factors must be considered when calculating the entertainment amount allowance that is subtracted from the salary:
- For this purpose, a person’s perks, allowance, and other perks and benefits are not considered part of the ‘salary.’
- Out of the stipend for entertainment received, the actual amount spent on amusement is not taken into account.
Section 16 (iii): Tax on Employment or Professional Tax
The employment tax is covered under clause (2) Article 276 of the Constitution of India and is determined by each Indian State separately. According to this subsection, a professional tax or employment tax is allowed to be deducted. The following considerations must be made in this case:
- The deduction is allowed only in the year that professional or employment tax is paid.
- The professional tax is counted in the salary amount even if an employer pays it on behalf of an employee.
- A professional tax of more than ₹2,500 cannot be deducted in a year.
Provisions Covering Eligibility under Section 16
You may wonder who is eligible for deductions and allowances as per Section 16. The eligibility criteria vary based on the type of deduction or allowance you plan to claim. Generally, you must meet certain requirements to qualify for specific deductions and allowances.
- 16 (ia): Typical Deduction [50,000 or the salary, whichever is less].
Who can claim – Salaried assessees & Pensioners
- 16(ii): Expense for entertainment [actual or, if less, at the rate of one-fifth of salary] [limited to ₹5,000]
Who can claim – Government personnel
- 16(iii): Employment tax
Who can claim – Salaried assessees
It is important to note that only individuals claim deductions or allowances under Section 16. Businesses are not eligible for a deduction under this section.
Documents Required to Claim Deductions
Individuals are not required to provide any documentation to claim the standard deduction under Section 16 of the Income Tax Act.
Irrespective of an individual’s salary, the maximum allowable standard deduction is ₹50,000. If a person’s net pay is less than ₹50,000, the sum of all deductions under Section 16 shall not exceed the amount of their salary.
How to Comply with Tax Provisions under Section 16
Familiarity with the Income Tax Act can be challenging, particularly when considering deductions and allowances. It is advisable to have a deep understanding of what deductions you qualify for to maximise the benefit of your tax return.
Examples for Salaried Employees
The Income Tax Act provides a variety of mechanisms for residents to claim deductions and refunds on their income. Based on how taxpayers use their money, deductions are permitted. The standard deduction is the deduction allowed to those who receive a salary.
As an illustration, let us say your salary information is as follows:
Basic salary: ₹6,00,000
Special Allowance: ₹2,00,000
EPF contributions totalled ₹30,000.
PPF deposits: ₹50,000,
Allowance for travel: ₹20,000
As a result, your total income is equal to (6,00,000 + 2,00,000) = ₹ 8,00,000.
Total Gross Income =8,00,000 – (30,000 + 50,000) = ₹7,20,000
After the standard deduction:
₹(7,20,000 – 50,000) = ₹6,70,000 is your taxable salary income.
Your tax obligation is equal to ₹12,500 plus 20% of (6,70,000 – 5,00,000) = ₹34000
Thus, the standard deduction allows you to reduce your tax liability. For AY 2022–23, you can only use this deduction if you opt for the provisions under the old tax regime.
Additionally, your company is not required to process any bills or invoices for you to benefit from this tax deduction. This facility avoids complex paperwork and simplifies tax calculations.
Key Benefits under Section 16
The 2018 budget allowed for a standard deduction of ₹40,000 as an alternative to travel allowance and medical reimbursement. A taxpayer is not obligated to provide any bills or proof of expenditure to avail of a deduction of ₹40,000. Such a deduction is an unconditional allowance of ₹40,000.
In the 2019 Interim Budget, the deduction was raised from ₹40,000 to ₹50,000. This means that the deduction for FY 2018-19 was ₹40,000, and the deduction for subsequent fiscal years will be ₹50,000.
Pensioners may also take advantage of the standard deduction. Taxes apply to any pension received from previous employment under the category of ‘Salaries.’ The pension they receive is taxable under the ‘salaries’ head, and pensioners can avail of the deduction under section 16.
Q1: What is the applicable rate of professional tax on salary income?
A: The professional tax that may be charged in any given year is ₹2,500.
Q2: Are pensioners eligible for the standard deduction under Section 16?
A: Yes, pensioners are eligible. The pension received is subject to taxation as a part of salary income. Hence, this deduction applies to pensioners as well
Q3: Am I eligible for a deduction for entertainment expenses even though I am a non-government employee?
A: Unfortunately, the deduction for entertainment allowance is not available to individuals employed in private firms. It is exclusive to employees of the Central or State Governments.
Q4: Is there any documentation to be submitted for claiming a standard deduction under Section 16?
A: For the standard deduction, no records are required. You do not need to give your employer or the tax office any proof of your expenses to be eligible for this tax credit. It is a flat tax deduction allowed on salary income.
Q5: I changed my employer in the middle of the last financial year. Can I get a standard deduction on the wages I earned from each company separately?
A: The standard deduction is a predetermined sum that is subtracted from the employee’s annual base pay. It still holds, regardless of how many jobs the individual has held. There is just a single flat deduction of Rs. 50,000 allowed for the total compensation received from all employers combined.