Are you curious about the various allowances you may receive as part of your salary in India? Whether you are a working professional or a business owner, understanding the types of allowances and their tax implications is essential. This will help you plan your taxes more effectively.
Key Takeaways
- Allowances play a significant role in your compensation package, falling into three categories: taxable, non-taxable, and partially taxable.
- Taxable allowances are fully integrated into your salary and subject to taxation, while non-taxable allowances are tax-exempt and deducted from your gross salary.
- Partially taxable allowances enjoy tax exemption up to a specified limit outlined in the Income Tax Act.
- Understanding allowances and their tax implications is essential for sound financial planning.
- Collaborating with a tax advisor or consulting the latest tax guidelines ensures you have the most accurate and current information.
Allowances are a vital component of your salary, providing financial assistance for specific expenses. Your employer can pay these on top of your basic salary to meet various needs and necessities. Allowances are added to an individual’s salary and subject to tax under the head Income from Salaries under the Income Tax Act of 1961. Salary allowances are categorized into three groups: partially taxable, non-taxable, and taxable. However, not all allowances are treated the same regarding taxation. Several types of tax allowances can be availed of if you have the proper knowledge about them.
Types of Allowances for Employees
There are two broad categories of allowances: taxable and non-taxable allowances. However, there is a mixed category where partially taxable allowances are covered. Here are the details for these three categories:
Taxable Allowance
Allowances that are included in salary and are not covered by the Income Tax Act in any way are considered taxable. These are subject to taxation based on the employee’s tax slab. The following are a few well-known taxable allowances:
- Dearness Allowance
Dearness Allowance is a part of a salary that is a set percentage of the basic pay that can be affected by inflation. As DA and the cost of living are directly correlated, the DA component varies depending on the employee’s location. This means DA is different for employees in the urban sector, semi-urban sector, or rural sector.
- DCity Compensatory Allowance
CCA or City Compensatory Allowances refers to a benefit that employers—public or private—offer to their staff as a way to offset the higher cost of living in Tier-1 or metropolitan areas. There is no upper or lower limit for CCA, and if the amount exceeds ₹900/-for all taxation purposes, CCA is fully taxable.
- DFixed Medical Allowance
Medical allowance is a monthly fixed benefit that employees of a company receive regardless of whether they provide bills to support the expense or not. This benefit is fully taxable for individual salaries.
Non-Taxable Allowances
These allowances are considered part of an employee’s salary but are fully exempt from income tax. This means that when calculating taxable income, these allowances are deducted from the gross salary. Here are some commonly known tax-exempt allowances:
- Uniform Allowance
This allowance covers purchasing or maintaining uniforms required for work. It is exempt from the actual amount spent on these expenses.
- Sumptuary Allowance
Sumptuary allowances granted to High Court judges under Section 22C of the High Court Judges Act, 1954, are not taxable.
- Compensatory Allowances
Compensatory allowances received by judges under Article 222(2) of the Constitution are not taxable because they are not considered part of salary or perquisites.
- Helper Allowance
Helper Allowance compensates employees for the expenses incurred on hiring a helper for official duties.
- Leave Travel Allowance (LTA)
LTA is non-taxable for the expenses incurred on actual travel, subject to certain rules and restrictions.
Partially Taxable Allowances
These allowances are exempt from tax to a certain limit, as instructed in the Income Tax Act. Here are a few commonly known partially taxable allowances:
- House Rent Allowance (HRA)
HRA is taxable if you live in your own house or do not incur any rent expenses. The amount of HRA exempt from tax is determined based on your actual rent paid and your salary structure. It can be partially or fully tax-free. The least of the following is exempt:
- Actual HRA received
- 40% of salary (50% if the house is situated in Mumbai, Calcutta, Delhi, or Madras)
- Rent paid minus 10% of salary
HRA is taxable if it is received by an employee living in their own house or if they do not pay any rent. Employees must report the PAN of their landlord to their employer if the rent paid is more than ₹1,00,000 [Circular No. 08/2013 dated October 10, 2013].
- Children’s Education and Hostel Allowance
Up to ₹100 per month per child, up to a maximum of 2 children is exempted. As per section 10(14), hostel expenditure allowance is up to ₹300 per month per child to a maximum of 2 children is exempted from the taxes.
- Entertainment Allowance
Employees receive this allowance to help with living expenses related to entertainment, etc. Only government employees are eligible for an entertainment allowance deduction under the Act; entertainment allowances for non-government employees are fully taxable. The deduction amount will be less than 1/5th of the basic pay or ₹5000, or entertainment allowance received by the employee
Way Forward
Understanding the types of allowances in India and their tax implications is crucial to plan your finances effectively. It is important to note that tax laws and regulations can change, so it is advisable to consult a tax professional or refer to the latest tax guidelines for the most accurate and up-to-date information.
In the field of taxation, keeping up-to-date with the rules and regulations can help you make informed financial decisions and ensure you are not caught off guard when it is time to file your tax returns. So, keep these distinctions in mind and make the most of the non-taxable allowances while being prepared for the taxable ones in the fiscal year 2022-23.
