Did you know that your salary components can help you save on taxes?
With almost 5.9 crore Indians paying income tax (as of 2018), taxes account for almost 27% of India’s total tax collections.
But tax rates, particularly the ones in the Old Regime, can significantly reduce spending power. That’s why, saving on taxes has definitely been at the back of every salaried individual’s mind at some point or another.
But navigating tax scenarios can be unnecessarily complicated, especially given the constant changes and revisions that occur every financial year.
In India, all individuals earning above INR 2.5 lac (under the old regime) and INR 3 lacs (under the new regime) are liable to pay taxes. The tax slabs vary from 5% to 30% under both regimes. These amounts can become especially significant when one pay hike can push an individual into an entirely different tax bracket by a slight amount.
Here’s a glimpse at the tax rates according to different slabs that determine the calculation of income tax in India:
But, since the introduction of the new tax regime in 2020, taxpayers have had the option to choose between two frameworks every financial year. While the old tax regime has some remarkably steeper tax slabs, there are more tax exemptions under it. The new regime, on the other hand, has a greater rebate limit and more gradual slab transitions, but has fewer tax exemptions for salaried individuals.
Salary Components That Save Tax Under the Old Regime
The old regime is preferred by employees who’ve got a significant amount of their finances locked in investments, loan payments, etc. The old tax regime offered over 70 deductions to help salaried professionals bring down their taxable income.
Keeping these tax-exempted salary components in mind can help companies reduce the tax liabilities of their employees, as well. Employees can also understand these tax-saving components to negotiate a better salary break-up if they intend on opting for the old tax regime.
These are the well-known tax savings components in salaries:
1. Standard Deductions
Initially introduced in 1974, this deduction allowed salaried employees and pensioners to claim an exemption amount from their gross salary, regardless of which tax slab they fell under. This amount was INR 40,000 until 2018 but was increased to INR 50,000, where it stands today. There’s no mandate to submit any proof of spending or investments to claim this deduction.
2. HRA
House Rent Allowance is a standard salary component for most salaried professionals in India. This allowance is completely taxable unless they live in a rented place. They must submit valid proof of rent payments or a tenant agreement to claim this deduction. The HRA exemption amount can be claimed as the lowest of either of these:
- The actual HRA received
- 50% of the sum of basic salary and DA (for employees living in metro cities)
- 40% of the sum of basic salary and DA (for employees living in non-metro cities)
- Actual rent paid subtracted from 10% of the sum of basic salary and DA
This deduction, however, cannot be claimed by self-employed professionals under Section 10 (13A). Instead, they can claim it under Section 80GG.
3. LTA
Leave Travel Allowance is given to employees to cover domestic travel when they’re on leave. This allowance covers costs incurred through any form of public transport, like trains and flights. LTA can only be claimed for travel expenses, not lodging, food, or any other expenses incurred while traveling.
To claim the LTA allowance, employees must submit proof of travel, including tickets and invoices, that can be approved. LTA can be claimed twice in a block of four years, which are set by the government.
4. Section 80
Employees can claim tax deductions from investments under Section 80C of the Income Tax Act. By investing in Equity Linked Saving Schemes, National Pension Scheme, Public Provident Fund, National Saving Certificate and even Employee Provident Funds, tax exemptions of up to INR 1.5 lacs can be claimed by salaried professionals.
Meanwhile, Section 80D grants individuals exemptions on medical insurance premiums up to INR 25,000, preventive health check-ups up to INR 5000 and medical expenses for disabled dependents up to INR 75,000 – INR 1,25, 000. It usually depends on the level of disability to determine the final amount.
Other sections of Section 80 can allow employees to claim exemptions for interest on savings accounts, house rent, education loans, home loans, charitable donations, and even royalty from patents.
5. Meal Coupons
Companies can often provide employees with meal coupons, which are taxable. But they can be tax exempt up to Rs. 50 per meal. While the amount may seem minimal, it can be cost effective in the long run. Considering employees don’t have to spend on food, it can help them minimize their daily expenditure. Besides these exemptions, counted twice a day, can also add up to approximately INR 26,400 a year, which is a significant amount.
6. Books and Periodicals Allowance
This allowance is completely non-taxable and is given to employees for welfare and personal development. Employees are reimbursed for any money spend on books, magazines, newspapers, or periodicals. This exemption can be claimed within a year from the date to purchase. Employees must submit the original receipts and proof of purchase to ensure that they receive proper disbursement.
The reimbursement amount, however, is determined by either the bill purchase amount or the allowance amount given by the company, whichever is lower.
7. Phone and Internet Bill Reimbursements
Companies can offer their employees an allowance for phone and internet bill reimbursements as part of their CTC. This can help employees with phone and internet expenses required for work. The allowance amount is set by the company.
These reimbursements are completely exempt from taxation, as per Section 10 of the Income Tax Act. Employees can either be reimbursed the billed amount or the maximum allowance limit, depending on which is lower. However, employees do need to submit a proof of expense to claim this reimbursement.
8. Children’s Education Allowance
Organizations can offer employees special salary components that qualify for a child’s education allowance. This allowance amount, up to INR 100 per child, is exempt from taxes.
Likewise, individuals can also claim a tax exemption up to INR 300 a month as a hostel expenditure allowance. Both of these exemptions can be claimed for a maximum of two children at a time.
The tax exemptions can only be claimed if employees can show actual proof of expenses. It is also mandatory for them to claim these expenses in the same financial year as the expenses.
9. Car Maintenance Allowance
Employees can also leverage tax exemptions on car maintenance allowances, depending on who owns the car. If the car is owned or leased by the employer, this prerequisite becomes taxable. Employees are liable to be taxed on amounts up to INR 2,700 (for engines up to 1,600cc) or INR 3,300 (for engines above 1,600cc).
However, if the car is owned by the employee, these amounts become tax exempt if they’re reimbursed by the employer.
10. Gifts
As per Section 56 of the Income Tax Act, gifts are taxable only if they have significant monetary value. If they are valuable enough, they will be classified as ‘income from other sources.’ But, if the perceived valuation of the gifts is under INR 50,000, then they are not taxable. Gifts received from family or relatives are also not taxable.
But it is worth nothing that if an individual receives multiple gifts that exceed the valuation of INR 50,000 combined, in that case, the entire amount can be taxed.
Salary Components for Tax Exemptions Under the New Regime
The new tax regime has far fewer exemptions, but if you’ve chosen the new regime for reduced tax rates, then you can still claim exemptions on the following:
- Standard Deductions: The INR 50,000 standard deduction from taxable income has been included in the new regime since 2023.
- Official Duty Allowance: Any salary components or allowances given as compensation for on-duty tours, traveling for work reasons, and conveyance allowance for travel to the workplace are tax exempt under the new regime.
- Life Insurance: The amount received upon maturity of life insurance policies also qualify for tax exemptions.
- Employer contributions to EPF/NPS: Employer contributions up to INR 7.5 lacs to pension accounts are also tax-exempt.
- NPS withdrawals: Up to 60% of the NPS balance can be withdrawn upon maturity without the amount being added to taxable income.
- Interest on EPF, Post Office Savings Accounts: Interest earned on EPF and Post Office Savings Accounts is also tax-exempt up to a certain percentage.
- Retirement Benefits: Gratuity and leave encashment amounts are exempt from taxes up to a certain limit. However, gratuity received upon the death of an employee is completely exempt from taxes.
- LTCG: The new regime also allows deductions up to Rs. 1 lakh on long term capital gains. An income received from selling equity shares or equity-oriented mutual funds are exempt up to the specified amount.
- VRS: Payments up to Rs. 5 lakhs, received under the Voluntary Retirement Scheme are also considered non-taxable.
Summing Up
Salary components that can help you save on taxes can be a great way to maximize your spending power. The old tax regime can help you save significantly on taxes if you’re able to max out the provisions under Section 80. But if you don’t have substantial investments or loan payments, you can consider the new regime for lower income tax percentages.
HR teams can further empower their employees by ensuring transparency in tax calculations by using payroll management software. This will not only allow employees to understand their tax liability better but negotiate better salary breakups, which can help them save taxes.
What is your preferred tax regime and why? Let us know in the comments.
