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The article elucidates the various aspects of salary income, including the tax calculation and the deductions allowed on salary income.

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How is Tax Calculated on Salary?

Income earned by an individual can be broadly classified under 5 distinct heads and taxed according to the Income tax rules governing them. The 5 heads of income are: 
  • Salary Income
  • Income from house property
  • Business or Professional Income
  • Capital Gains
  • Other Income 
We shall discuss in detail the first head of income namely Salary Income and how is tax calculated on the same.
 
What is Salary Income?
Salary means remuneration paid to the employee by the employer for the services rendered by him during a period of time. It is taxed on due basis or receipt basis, whichever is earlier. Salary comprises of 5 components namely: 
  • Basic Salary
  • Fees, Commission and Bonus
  • Allowances
  • Perquisites
  • Retirement Benefits
Basic Salary
Basic salary is a fixed component of the salary which is agreed upon as per terms of employment or as per the graded system of salary. As per the graded system, the increments are fixed till the basic salary reaches a prescribed limit for the grade.
 
Fees, Commission and Bonus
Fees and bonus paid to the employee is part of taxable salary. Commissions paid to employees maybe fixed or a percentage of turnover achieved by the employee. If commission is paid a s part of percentage of turnover, the same is added to the basic salary for the purpose of computation of retirement benefits.
 
Allowances
Allowances are fixed amounts paid by an employer to an employee to meet his expenses for personal use or for performance of his professional duties. The allowances are over and above the basic salary and are taxable as per their nature and guidelines laid by the Income Tax Act. These allowances can be classified as:
 
Fully Taxable
Fully taxable allowances are as under:
 
Dearness Allowance
This allowance is paid to meet the mounting expenses due to inflation. In some cases it forms part of basic salary for computing retirement benefits.
 
City Compensatory Allowance
This allowance is paid to employees who are transferred to big metros like Mumbai, Delhi, and Chennai where the cost of living is higher than other cities.
 
Overtime Allowance
Any allowance paid for working over and above the prescribed hours is called overtime allowance and is fully taxable
 
Other Allowances
There are many other allowances that are taxable such as deputation allowance, servant allowance, etc. 
 
Partly Taxable
Partly taxable allowances are as under:
 
House Rent Allowance (HRA)
This allowance is paid to the employee to meet the rental expenses for residential accommodation for self. If the employee lives in his own house, then the HRA is completely taxable. The exemption amount of HRA for rental property is least of the following: 
  • Actual HRA
  • Additional rent paid over and above 10% of salary due to him
  • An amount equal to 50% of salary due to him if living in metros (40% of salary if living in other places) 
Entertainment Allowance
This allowance is first included in the salary and is then allowed as an exemption only to Central and State Government employees.
 
Special Allowance
This allowance is given to the employee for carrying on his official duties and is exempt to the extent it is actually incurred. This includes uniform allowance, travel allowance, research allowance, etc.
 
Special Allowance to meet personal expenses
A fixed allowance is paid to the employee to meet his personal expenses. This allowance is fixed and a reimbursement of the entire expenditure incurred. Eg: Children Education Allowance, Children Hostel Allowance, etc.
 
Fully Exempt
Fully exempt allowances are as under:
 
Foreign Allowance
Allowances given to employees posted abroad for carrying out their professional duties are completely exempt from tax
 
Allowance given to High Court and Supreme Court Judges
Allowances of any kind given to High Court and Supreme Court judges are completely exempt from tax
 
Allowance given to UNO Employees
Allowances given to employees of United Nations Organisation are completely exempt from tax.
 
Perquisites
Perquisites are emoluments received by an employee by virtue of holding the position and office over and above his salary. They benefit the employee and are not just reimbursement of expenses. These benefits are also in kind and can be valued. Perquisites can be again classified under three heads:
 
Perquisites that are taxable for all employees: Some perquisites that are taxable for all employees are: 
  • Rent free accommodation
  • Concession in rent of accommodation
  • Interest free loans or subsidized loans
  • Movable assets or transfer of assets
  • Payment of club fees
  • Payment of educational expenses
  • Payment of insurance premium, on behalf of employees 
Perquisites that are taxable only for specified employees
Specified employees are employees who are either directors in the organization or have substantial interest in the organization or their salary was over Rs.50000/- in the previous year: 
  • Free gas, electricity, water supply for domestic purposes
  • Free or concessional educational expenses
  • Gardener, sweeper, attendant
  • Free or concessional transport facility
  • Any other benefit or amenity 
Perquisites that are exempt from tax
Some perquisites are notified by the Income Tax Departmentwhere fringe benefit tax has to be paid by the employer on the expenses incurred by them on the perquisites. These fringe benefits are absolutely exempt from tax in the hand of the employee. These include: 
  • Medical Benefits
  • Leave Travel Concession
  • Health Insurance Premium
  • Car, laptop, computers for personal use
  • Staff Welfare Schemes
  • The perquisites which are taxable are valued as per the rules laid down in the Income Tax Act. 
Retirement Benefits
These benefits are provided either at the time of retirement or during the period of the service. Each benefit has a different tax treatment. The various benefits are:
 
Pension
Pension is a reward for the services rendered by the employee> It is usually disbursed as a monthly payment, but sometimes the employee may opt for a lumpsum payment. The tax treatment depends on the option chosen and on the category of employee.
 
Gratuity
Gratuity is a payment received in appreciation of past performance. It is received on retirement. It is exempted upto a certain limit and also dependent on the type of employee.
 
Leave Salary
Privilege leave is accumulated in the account of the employee. The employee may avail of leave or may opt for encashment of leave accumulated. This is permitted either during the tenure of service or at the time of retirement. The tax treatment will depend on the option chosen and on the category of employee.
 
Provident Fund
Contribution towards Provident fund is deducted on a monthly basis from the salary of the employee. An equal amount is also contributed by the employer. At the time of retirement the accumulated balance in the Provident fund account along with the interest is given to the employee. The tax treatment of the proceeds depends on the type of provident fund maintained by the employer.
 
Deductions allowed from Salary: The following deductions are made from the salary income to reach the net salary income:
 
Standard Deduction: This deduction has been discontinued from Assessment year 2006-07
 
Entertainment Allowance: This is first included in the salary and then allowed as a deduction to the State and Central Government employees. The deduction amount is the least of 
  • Rs.5000/-
  • Entertainment allowance actually received
  • 20% of basic salary

Professional Tax: Professional tax also known as tax on employment is first paid by the employer and then allowed as a deduction from salary. It is allowed only in the year in which it is actually paid.

Computation of Net Salary of an Employee
 Particulars
 Amount (Rs)
 
 
 Basic Salary
 
 Fees Commission and Bonus
 
 Allowances
 
 Perquisites
 
 Retirement Benefits
 
 
-------------------
 Gross Salary           
-------------------
 
 
 Less: Deductions from Salary
 
            Standard Deduction
 
            Entertainment Allowance
 
            Professional Tax
 
 
-------------------
 Net Salary
-------------------

  • HETAL SOLANKI:
    my question is about professional tax deduction. last year my salary is RS. 8000 AND i paid professional tax RS. 80 NOW I GOT increment AT 20% AND my salary is now RS. 9600. and i got difference also for last year from 29th AUGUST 2012 TO MARCH-13. Total difference is rs. 11355. how much amount of professional tax is deducted from my difference of RS. 11355. i am from Gujarat. So please solve my query.
    20-Jun-2013 11:23 AM
  • shahid khan:
    Nice Explaination
    06-Jun-2013 07:03 PM
  • Raghuvar Bisht:
    thanks. nice explanation on Income TAX.
    29-May-2013 03:42 PM
  • Sylvester:
    My wife's annual salary is Rs. 2.4 lacs. She is paid cash every month by her employer. want to know what would be the yearly income tax deduction for 2.4 lacs?
    28-May-2013 11:56 PM
  • Kamal Mitra:
    I am an Accountant in a company, Say taxable employee is five person, total tax of them is 4500 in a month, how I treat in cash book ?
    14-May-2013 07:44 PM
  • ankit jain:
    How to fill professional tax which should be shown as deduction while filing TDS Return.
    14-May-2013 12:47 PM
  • Janardan Raccha:
    I have query related to deduction of professional tax on overtime. Please see the below example to understand the query.

    An employee is earning Gross of Rs. 8000/- and of Rs. 4000/- so what will be the PT deduction, whether it is 175/- or 200/-.

    Kindly confirm the same and do the needful.
    08-May-2013 06:10 PM
  • PRATEEK:
    MY BASIC IS 8100/ HRA 3000/ SPECIAL ALLOWANCE 7888/ PERFORMANCE BONUS.2500 EDUCATIONAL ALLOWANCE 2260 *& SR AGENT ALLOWANCE 3000

    PLEASE ADVISE PF & TAX TO BE PAID BY ME PER MONTH

    ITS VERY URGENT PLEASE
    28-Apr-2013 10:12 PM
  • UMESH RAM:
    Sir,
    I have been sanctioned self lease of my own house for Rs. 17680
    and every month a sum of Rs. 1780 is deducted from my salary towards license fees for leased house.
    every month I am being paid a sum of Rs. 15990 now in salary but separately. THIS IS NOT REFLECTED IN SALARY.
    I have taken HBA FOR MY SELF LEASED HOUSE.

    PLEASE ADVISE HOW TO CALCULATE TAX ON THIS AMOUNT OF SELF LEASE PAID TO ME MONTHLY
    03-Apr-2013 04:25 AM
  • Sreekumar:
    Wanna know more
    02-Apr-2013 11:50 AM
  • swapan kr. ghosh:
    what about the interest on housing loan , interest on education loan and mediclaim expenses
    23-Mar-2013 08:01 AM
  • sumanth gojanur:
    madam,
    i have a LIC OF 27,000 AND HAVE GIVEN SCHOOL TUTION FEES OF 14000 FOR MY KID,I HAD INVESTED IN A PROPERTY ON PLOT AND GOT AXIS BANK LOAN FOR WHICH I PAY 42000/- MONTHLY AND I HAD ALSO GIVEN 42,000 AS PROPERTY INSURANCE IN 2011 FOR THE SAME.
    NOW WHAT IS THE BEST WAY TO PUT MY TAX SAVINGS AS I HAVE MENTIONED ABOVE AS LIC AND SCHOOL FEES..KINDLY LET ME KNOW WHICH INSTRUMENT TO INVEST REMAINING AMOUNT ,ACTUALLY NOW DIFFICULT SITUATION & 31 MARCH LAST DAY TO SAVE TAX
    REGARDS
    SUMANTH GOJANUR
    22-Mar-2013 02:06 PM
  • S.K.DAS:
    How many % perquisites tax?what are add in per.tax? Gross salary or only basic & DA?
    25-Feb-2013 09:43 PM
  • ravi main:
    is personal allowance is taxable
    16-Feb-2013 10:59 AM
  • Rajesh V Thakur:
    Suppose any employee's Gross Salary is Rs/- 9800 PM, so we deduct his Professional Tax Rs/- 175 PM. But One Month he done Overtime (say Rs/- 500) his Salary Crossed Rs/- 10000. For this his Salary for the Month is 10300 ---- We deduct Professional Tax Rs/- 200 ? or 175 Please give me answer for it that how tax deducted.
    01-Feb-2013 04:13 PM
  • Saadat:
    So how to Create Salary details it means PF,PT,Conveyance sheet from salary after deduction
    30-Jan-2013 03:31 PM
  • satish chandra:
    I am an central government employee and I am not getting medical allowances, but I have received Rs.84000/- towards medical reimbursement. Whether i.tax will be applicable on it or not.
    25-Jan-2013 07:42 PM
  • Avani:
    Hi Mrs. Sharma,

    The article is really informative. But I want to learn the percentage of deductions from each section while calculating the payroll of the employee, eg. Basic Salary, PF, PT, etc. Then this would help us know better and can calculate on our own. Please do this favor for me.
    15-Jan-2013 03:37 PM
  • krsaravanan:
    dear sir, i want pay my income tax please explain how they calculate from salary my annual income 8,40,000 how many percent to pay per paying period total months
    03-Dec-2012 04:43 PM
  • Owais:
    Nice article
    28-Nov-2012 05:59 PM
  • KARTHIKEYAN V:
    SECTION 80C, EXEMPTED HOW MUCH AND ALL MUST BE MENTION?
    12-Oct-2012 04:58 PM
  • catherin:
    Can you explain me how to calculate professional tax for salaried person. Should the calculation be on basic or gross salary? If its gross salary kindly explain why? Or give me the specifation given in the act
    12-Sep-2012 01:01 AM
  • samu:
    This is very helpful, thanks a lot
    28-Aug-2012 06:07 PM
  • Kishore Kumar Nanda:
    My employer is paying me the fixed allowances as below
    1.Lunch
    2.LTA
    3.Medical
    You may clarify whether these are exempted for arriving taxable income, if so how to compute the taxable income. I am confused as the opinions vary.
    12-Aug-2012 12:05 AM
  • aadil:
    Thanks mam.. i am very thankful to you after taking such information from you. my exams are nearer to me and i dint have any type of notes or books, but still i got the information. it would not be possible for me, without your help.. again a big thanks to you mam and i would like to hear from u..
    02-Jul-2012 12:56 PM