0 hidden charges. 0 forex
debit-card
Open a Fi Salary account and manage your salary with ease

What is Arrears in Salary and How it Works?

article image

What is Arrears in Salary and How it Works?

Table of Contents

Salary arrears refer to unpaid wages or compensation that an employee is owed for work that has already been completed. This can happen for a variety of reasons, such as an employer not having enough funds to pay employees or a delay in processing payroll. 

Let’s take a deeper look at them 

What are Arrears in Salary?

A salary arrear refers to an unpaid salary with amount due from the past.

Salary arrears are common when employees receive salary hikes in one month, but the hiked amount is credited in the following month. Other than that, the following reasons might also cause arrear payments:

  • The company has missed payments 
  • Delay in payroll processing
  • Failure to settle reimbursement claims on time
  • Issues in transferring bonuses
  • Companies where payments are made only once the service is completed

How are Salary Arrears Calculated?

It’s best to take a real-world example to understand the meaning of a salary arrear and how it is calculated. 

Say, you earn a salary of ₹15,000 and receive a salary hike of ₹2,000, effective from the month of April. However, due to some payroll issues, this hiked amount was credited to his account only in August. 

The salary arrear accumulated over the last five months will be ₹10,000. Thus, in this case, his August salary will be ₹25,000 (15,000 + 2,000 x5). 

Are Salary Arrears Subject to Income Tax Deductions?

Income tax deductions are applicable on income earned in the current fiscal year. If you receive due arrear payments in the same financial year, they will be taxed as part of your yearly net income as per the applicable income tax slab. 

However, adding overdue salary payments from previous years to the current year can increase your net income and push you into a higher tax slab. 

To save you from add-on tax burdens, the Income Tax Act offers some relief from salary arrear inclusions under Section 89(1). You can claim relief under this section if you are in a lower tax bracket for the year the dues get credited. To claim this tax relief, you must fill out Form 10E. 

How to Calculate Tax Relief on Salary Arrears?

You can calculate tax relief on salary arrears by following these steps: 

Step 1: Calculate the tax payable on your total income (including arrear salary) in the receiving year. 

Step 2: Compute the tax owed on the receiving year's earnings (excluding the arrear payments).

Step 3: Deduct the second amount from the first amount. This value represents the add-on tax liability created due to arrear income. 

Step 4: Calculate the tax payable in the years to which the arrears apply (excluding arrear income).

Step 5: Calculate the tax payable in the years to which the arrears apply (including arrear income).

Step 6: Compute the difference between these two values. The resulting sum represents the actual tax liability for the year the arrears pertain to. 

Step 7: If the value computed in Step 3 exceeds the Step 6 results, you will be entitled to tax relief. Your tax relief under Section 80(1) will be equal to this excess value. However, if the tax computed in Step 3 is lower than that computed in Step 6, you won’t be eligible for relief and can skip filling out form 10E. 

Conclusion

Salary arrears are deferred payments made by the employer to the employee. While salary arrears generally result from pay hikes, they can also be caused by a host of other reasons. Section 80(1) provides tax relief from adding back-dated arrears that can often push the employee into a higher tax slab.   

Frequently Asked Questions

1. What is an example of Salary paid in arrears?

A back-dated salary increment can be the best example of arrear payments. Say, Shweta has a salary of ₹20,000 and receives a salary hike of ₹5,000, effective from April. However, due to payroll issues, the increment doesn’t get deposited into her account until August. In this case, Shweta will receive a total of 45,000 in August, where 25,000 is the arrear payments accumulated over the last five months. 

2. What happens if I get an arrear?

If you get an arrear in the payroll, it simply means that a part of your salary will be credited later. In such cases, your employer will credit the amount to you in the coming months. 

Want to know more? Read on

1. Decoding your gross salary

2. Salary structure components : How to Calculate your Salary

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

4. What is CTC? Here is what you need to know

5. What is Salary increment and how to calculate it

Time to switch to Fi. Smart banking and only that.
Related Posts
Get the Fi app