Apr 238 min read

How to Calculate Income Tax on Salary with Example

Q: What components of salary are taxable?

All the components of salary such as basic pay, house rent allowance (HRA), special allowances, and bonuses are taxable. However, certain exemptions and deductions are allowed to be claimed to determine the taxable salary.

Updated: Jul 3

Calculating the income tax on your salary can be a difficult process. But with an easy, step-by-step guide, it becomes a lot simpler. This article will walk you through the process of calculating income tax under the old and new tax regimes, with detailed examples to demonstrate each and every step. Whether you are a new taxpayer or want to improve your understanding on calculating the income taxes, this article will provide you with the information you need to determine your tax obligations confidently.

How to Calculate Income Tax on Salary?

To calculate income tax on salary: Determine total income, apply eligible deductions, and compute tax liability based on relevant slab rates for the financial year. Below steps are to be followed for calculating income tax on salary:

Step 1: Understanding the Gross Salary: The gross salary comprises basic salary, house rent allowance (HRA), special allowances, and any other type of income in the nature of salary. To determine the gross salary, all the components of salary are to be added up.
Step 2: Calculation of Taxable Income: The formula for calculating the taxable income is: Gross Salary - Exemptions (like HRA, LTA) - Deductions (80C to 80U). The taxable income comprises gross salary minus eligible exemptions and deductions. Common deductions include investments made under Section 80C, health insurance premium under Section 80D and interest on home loan under Section 24.
Step 3: Applying the Income Tax Slabs: Based on the chosen tax regimes apply the tax rates. Since India has two tax regimes: the old and the new. Under the old tax regime, a higher exemption and deductions are allowed. On the other hand, the new tax regime offers lower tax rates with minimum exemptions.
Step 4: Calculation of Tax Liability: Based on the selected tax regime apply the tax slabs and compute the tax liability. Also, add cess and surcharge, if applicable.
Step 5: Calculation of TDS and Final Tax Payable: Subtract the Tax Deducted at Source (TDS) from the total tax liability to determine the final tax payable or refundable.

Components of Salary

The components of salary vary greatly between various organizations. However, there are few common components that are important for both employers and employees. Following are the common salary components:

Basic Salary: Basic Salary is the core component of one's salary package, which forms an integral base on which other parts of the salary are determined. It forms the base part of an individual's compensation structure and is usually fixed in nature. Basic salary normally determines and links all other components like the provident fund, gratuity, pension, and so on.
House Rent Allowance (HRA): HRA is given to employees so that they can cope with the cost of living or housing expenses. This allowance is also helpful from the point of view of income tax, as it is partially or completely exempt from taxes subject to some conditions which are dependent on the salary and the location of the residence.
Dearness Allowance (DA): Dearness Allowance is provided to the staff with an objective of covering the increase in the cost of living, arising from the impact of inflation. This component is more common among the public sector employees. It gets revised after periodic intervals, depending upon the rates of inflation.
Conveyance Allowance: Given to employees as reimbursement for travels by the employees from home to work and back to home. This is exempt from taxes subjected to a certain limitation of allowance under the Income Tax Act.
Medical Allowance: This allowance is given to employees to compensate for the medical expenses incurred by them. This can be claimed as exempt upon producing relevant medical bills; otherwise, it is taxable.
Leave Travel Allowance (LTA): LTA reimburses the traveling expenses of the employee's holidays spent in India only. LTA can be availed for tax exemption subject to specified conditions in the Income Tax Act.
Bonus: Bonus is often a performance-related pay given to the employee to enhance his motivation and productivity. This can be a fixed amount or again linked to his performance metrics or company performance.
Provident Fund (PF): PF is payable by every eligible employee, whereby a fixed percentage of basic salary is contributed to it by both employer and employee. It gets added into retirement funds that are to be paid out at retirement or under specified conditions.
Special Allowance: It is a residual category that covers various unclassified components of an employee's salary which do not fit into other defined categories. Special allowance is fully taxable.
Performance Incentives: Performance Incentives are additional remunerations rewarded to employees for outstanding work performance. These are normally linked to individual or team or company-based performance goals and may vary from one pay period to another.

How to Calculate Income Tax on Salary with Example for F.Y. 2023-2024: Under Old Tax Regime

Let us calculate the income tax on salary with an example of Ms. Neha, a salaried employee, for the F.Y. 2023-2024. Her tax liability under both the regimes, is calculated below:

Income Details:

Ms. Neha resides in a metro city where she pays INR 40,000 per month towards rent.

Exemption and Deductions Available under Old Tax Regime:

Exemption and Deductions Available under Old Tax Regime

Taxable Income Calculation under Old Tax Regime:

Taxable Income Calculation under Old Tax Regime:

Income Tax Calculation under Old Tax Regime F.Y. (2023-2024):

Income Tax Calculation under Old Tax Regime F.Y. (2023-2024):

How to Calculate Income Tax on Salary with Example for F.Y. 2023-2024: Under New Tax Regime

Let’s take the same example of Ms. Neha and determine her tax liability under the new tax regime:

Taxable Income Calculation under New Tax Regime:

Taxable Income Calculation under New Tax Regime:

Income Tax Calculation under New Tax Regime F.Y. (2023-2024):

Income Tax Calculation under New Tax Regime F.Y. (2023-2024):

Summary of Ms. Neha’s Tax Calculation under both the regimes:

Summary of Ms. Neha’s Tax Calculation under both the regimes:

Ms. Neha will be able to claim deductions and exemptions under the old tax regime which is otherwise not available under the new tax regime. Thus, the tax liability under the old tax regime is lower than the new tax regime. Thus, the above example presents the importance of evaluating personal expenses and investment options before selecting the tax regime.

How to Save Tax on Salary?

Saving tax on salary requires strategic planning and making good use of the various deductions and exemptions available under the Income Tax Act of India. Here is a list of suggestions to help on how to reduce your tax liability effectively:

Investment in Tax-Saving Instruments under Section 80C
Public Provident Fund: The instrument offers interest that is not only tax-free but also deductions on contributions, having an investment limit of up to INR 1.5 lakhs per annum.
Employees' Provident Fund (EPF): Contributions towards EPF are exempt from taxation up to the extent of INR 1.5 lakhs a year.
Equity Linked Savings Scheme (ELSS): Under this route, sub-avenues consisting of funds linked to equity with a lock-in time of 3 years are given for tax deduction purposes.
National Savings Certificate (NSC), 5-Year Fixed Deposits that banks offer, and Life Insurance Premiums are other ways of tax deductions.
Avail Section 80D Benefits
Medical Insurance Premiums: Deductions up to INR 25,000 for insurance premiums paid on self, spouse, and children, and additional INR 25,000 on parents, that is, INR 50,000 if both parents are senior citizens.
Claim your Allowance of House Rent (HRA)

If one pays rent and is getting HRA from his employer, he can claim exemptions under this provision. The exemption depends on the least of the following:

Actual HRA received.
50% of [Basic salary + DA] for metro cities, 40% in case of non-metros.
Excess of rent paid over 10% of [Basic salary + DA].

Deductions under Section 80E
Interest on Education Loan: The amount that is paid as interest on loans availed for higher education of self, spouse or children is allowed as a deduction.
Avail Section 24(b)
Home Loan Interest: In the case of a self-occupied house, the interest component of the EMI will be allowed a deduction of up to INR 2 lakhs.
Exemptions under Section 10
Leave Travel Allowance: The leave travel allowance consists of travel expenses enjoyed during leave from work. It is available twice in a block of 4 years.
Transport Allowance: Exemption is allowed towards money incurred to commute between home and office.
Additional Deductions
Section 80TTA: Interest income on savings accounts up to INR 10,000 is exempt from tax.
Section 80GG: If a person is not receiving HRA but he pays the rent; then he can claim deduction under this section.
Tax Planning through NPS National Pension System
Section 80CCD(1B): Invest up to a maximum of INR 50,000 in NPS over and above the INR 1.5 lakhs limit under Section 80C for additional deduction
Structured Reimbursement Plans
In your salary structure, include components such as food coupons, medical insurance, gadget allowances, and so on. These items can be claimed as an exemption from tax up to certain limits.
Consult a Tax Expert
Professional advice will not only optimize your tax savings based on your individual situation but also keep you updated with the latest tax laws and changes.

FAQ

Q1. What components of salary are taxable?

All the components of salary such as basic pay, house rent allowance (HRA), special allowances, and bonuses are taxable. However, certain exemptions and deductions are allowed to be claimed to determine the taxable salary.

Q2. How to compute the taxable income from salary?

To compute the taxable income from salary, take the sum of all the income from salary and other sources. From this amount, deduct exemptions from HRA, travel allowances, and other allowances. Subtract the deductions under Section 80 to arrive at the taxable amount of salary.

Q3. What is the standard deduction for a salaried individual?

For the financial year 2023-2024, the standard deduction for salaried employees is INR 50,000 under both the tax regimes. This a flat deduction allowed to the salaried employees for each financial year.

Q4. How is HRA determined for tax purposes?

House Rent Allowance (HRA) exemption is determined based on least of the following:

Actual HRA received, or
50% of salary if residing in metro cities (40% in case of non-metro cities),
Rent paid minus 10% of salary.

Q5. Is interest on a home loan allowed as a deduction from the taxable salary?

Yes. Section 24 of the Income Tax Act, allows for deduction of interest paid on home loan for INR 2,00,000, in case of self-occupied house property.

Q6. Is the Leave Travel Allowance (LTA) taxable?

The leave travel allowance (LTA) can be claimed as an exemption provided the travel costs are incurred within India, and the travel is undertaken while on employment. LTA can be claimed twice in a block of 4 years.

Q7. How are bonuses taxed in salary?

Bonuses form a part of the salary and are added while determining the tax liability. The tax is computed based on the applicable slab rates.

Q8. What is the consequence of not declaring all the components of salary for tax?

Not declaring all the components of salary may lead to incorrect computation of TDS on salary and thereby may lead to imposition of penalty and interest. Thus, not declaring all the components of salary for tax will affect the computation of tax liability.

Q9. What is the effect on tax deductions if a job is switched in the middle of the year?

If the employee switches the job in the middle of the year, all incomes earned from the previous year should be reported to the new employer. This will ensure that the new employer is able to determine the tax liability for the remaining period of the year correctly.

Q10. What is Form 16? How is it used in filing Income Tax Return (ITR)?

Form 16 is issued by the employer to the employee certifying the salary paid and TDS deducted during the year. It is very important for salaried employees for filing their ITR since based on Form 16, the ITR is filed for salaried employees.