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Separating the taxable and non-taxable components of your salary

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Separating the taxable and non-taxable components of your salary

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If you are a salaried employee, you should be aware that your taxable salary is not the same as your gross salary. There are some components that are partially exempt from tax, and others that are tax-free salary components. 

To help you better understand how your salary income is taxable, let’s take a closer look at the different components of a salary and how they are taxed. 

Basic salary

The basic salary is what you earn before adding any allowances or perks. It is the basic amount you get to take home each month, and it is on this sum that various other allowances are calculated. This component is fixed and is fully taxable. The tax on your basic salary is levied at the income tax slab rate applicable to you. 

Dearness Allowance

This allowance is paid by employers to help employees meet the rising costs of living over time. It helps mitigate the impact of inflation on your expenses. Typically, only government employees are entitled to receive Dearness Allowance as a part of their salary. This is a fully taxable component and is taxed at your applicable tax slab rate.

Bonus fees and commission

Your employer may also occasionally pay out a bonus or commission depending on the nature of your job and your performance at work. The components are variable and they are added to your total income. Any bonus and commission earned during the year are fully taxable. 

House Rent Allowance

The House Rent Allowance (HRA) is paid to help employees  meet the cost of rental accommodations. Most employers include HRA as a part of your salary and is generally offered as a percentage of the basic salary. HRA is taxed depending on whether you pay rent or not. If you do not pay any rent, the HRA you receive is fully taxable. 

On the other hand, if you live in rented accommodations, the least of the following amounts is exempt from tax:

  • Actual HRA received from your employer
  • Actual house rent paid minus 10% of your salary
  • 50% of your salary if you live in a metro city 
  • 40% of your salary if you live in a non-metro city

Here, salary is computed as follows:

Salary = 

Basic salary + Dearness Allowance (if it is a part of retirement benefits) + Turnover-based commission

Leave Travel Allowance 

Leave travel allowance (LTA) is a kind of monetary benefit paid by employers to help employees meet the cost of traveling within India, either alone or with their families. Here, the term ‘family’ includes your spouse, children and dependent brother, sister or parents. However, it does not include more than two children born on or after October 1, 1998.

LTA is partially exempt from tax. To claim this exemption, you need to keep the following conditions in mind: 

  • Only travel within India is eligible for the tax exemption
  • You should have actually taken the journey for which you are claiming the exemption
  • LTA exemption is available for two journeys in a block of four calendar years (the current block year is 2022 to 2025)

If the above conditions are met, the following exemption is available for the LTA earned as a part of the salary, depending on the mode of transport you take. 

Mode of travel

Amount of exemption

If you travel by airways

The exemption is limited to the air fare for the economy class charged by the national carrier along the shortest route connecting your origin point to your destination. 

If you travel by railways

The exemption is limited to the rail fare for the air-conditioned first class section along the shortest route connecting your origin point to your destination

If you travel by any other mode of transport, but your origin point and destination are connected by railways

The exemption is limited to the rail fare for the air-conditioned first class section along the shortest route connecting your origin point to your destination

If the origin point and the destination are not connected by rail, but are connected by any other recognized mode of public transport 

The exemption is limited to the fare for the first class or deluxe class section for the shortest route to the destination by the mode of public transport

If the origin point and the destination are not connected by rail or by any other recognized mode of public transport 

The exemption is limited to the rail fare for the air-conditioned first class section along the shortest route connecting your origin point to your destination

Children’s education allowance

This is an allowance that some employers pay their employees in order to help them fund the cost of their children’s education. This allowance is exempt up to ₹100 per month per child. You can claim this deduction for a maximum of 2 children.

Children’s hostel expenditure allowance

This allowance may be a part of your salary if your employer wishes to compensate you for any hostel expenses you may incur for your children. It is exempt up to ₹300 per month per child. You can claim this deduction for a maximum of 2 children.

Other partially exempt components and allowances

There are some allowances and components of your salary that are exempt only to the extent spent for official purposes. Here is a list of such allowances.

  • Conveyance allowance paid to meet the expenses of local travel in over the course of your job
  • Traveling allowance to meet the cost of travel for official purposes
  • Daily allowance to meet the regular expenses incurred on a daily basis for official purposes
  • Helper or assistant allowance paid to compensate any helper the employee may have
  • Uniform allowance paid to meet the cost of purchasing uniforms needed over the course of the job
  • Research allowance paid for the purpose academic research 

Allowances paid to specific personnel 

Apart from the above allowances, which may be paid to different categories of employees, there are some allowances paid to specific kinds of employees that are fully exempt from tax. These tax-free salary components are typically paid to the following categories of individuals:

  • Any allowance paid by the Indian Government to an employee posted outside India, provided the employee is an Indian citizen
  • Allowances paid to judges of the Supreme Court or High Courts
  • Allowances and perquisites paid to the serving Chairman or a Member of the UPSC
  • Allowances paid by the UNO to its employees

Other fully taxable components

Aside from the allowances discussed above, if you receive any of the following payments from your employer as a part of your salary, they  will be  fully taxable:

  • City compensatory allowance
  • Fixed medical allowance
  • Tiffin, lunch, dinner or refreshment allowance
  • Servant allowance
  • Project allowance
  • Overtime allowance
  • Telephone allowance
  • Holiday allowance
  • Any other cash allowance

Now that you know how to go about calculating your taxable income, you can understand your salary structure better and estimate your tax liability more accurately. Remember to avail all the deductions and exemptions that the Income Tax Act, 1961 offers for salary income to maximize your tax savings. 

Frequently Asked Questions (FAQs)

1. How is tax calculated on your salary?

Tax is calculated on salary after providing the necessary deductions and exemptions for the non-taxable components. In other words, you will only have to pay tax on the components that form a part of the taxable salary. 

2. Which income is taxable under your salary?

The taxable components of your salary iwill depend on how it is structured. For instance, you will have to pay tax on the basic salary, dearness allowance, medical allowance and profits in lieu of salary. 

3. How much of your salary is exempt from tax?

This depends on your salary structure and how much you earn. However, broadly speaking, the non-taxable components and partly-taxable components of your salary like house rent allowance, leave travel allowance and other such allowances are exempt from tax either completely or partially. 

4. How much tax will I pay if my salary is ₹50,000?

The tax liability on a salary of ₹50,000 can only be determined based on how this amount is broken up among different components. However, if ₹50,000 is the total of all the taxable components of your salary, and if you have no other taxable income, you need not pay any income tax because your income is below the annual basic exemption limit of ₹2.5 lakh. 

5. Which components of salary are not taxable?

Some components of salary, such as the House Rent Allowance (HRA), conveyance allowance, special allowance etc. are partly exempt from tax. 

6. Is salary income exempt from income tax?

No. Salary income is not exempt from income tax. The tax applicable on your salary depends on the components and the breakup of the total income you earn. 

7. Which salary is taxable: gross or net?

The gross salary (minus the eligible deductions) is the taxable amount. Meanwhile, the net salary is what you get after deducting the income tax, pension, professional tax and other such amounts. 

8. How do I figure out what my taxable income is?

To calculate your taxable income, add all the income that you earn from your employer and account for the complete or partial deductions. This will leave you with the taxable salary income.

9. How do you calculate tax for the financial year 2022-23?

To calculate the tax for FY 2022-23, find out your total income, choose a tax regime (old or new), and apply the deductions that you are eligible for to arrive at the taxable income. Then, on this amount, apply the income tax slab rate pertaining to your income to calculate the tax. 

10. What salary is tax-free in India?

No salary is entirely tax-free. Instead, certain components of salary are partially exempt from tax, such as House Rent Allowance (HRA) and conveyance allowance.

11. How can I make my salary tax-free?

While you cannot make your salary entirely tax-free, you can maximize your tax savings by claiming all the deductions and exemptions offered under the Income Tax Act, 1961. If your total taxable income after these deductions is less than the basic exemption limit, you will not have to pay any taxes, effectively making your salary tax-free. 

12. Is tax calculated on basic salary?

No. Tax is calculated on the basic salary plus all the other taxable components of the salary earned.

Want to know more about your salary? Read on

1. Your take home salary breakup explained using memes

2. Salary structure : Components and how to calculate them

3. Salary terms you should know before the end of the month

4. How to negotiate your salary or appraisal like a pro

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