Income Tax Exemptions for Salaried Employees


Income Tax Exemptions for Salaried Employees

Income tax is an important direct tax paid by an individual, or a HUF on the income received. Every year when the tax saving season is around people start looking for ways to save taxes on their hard earned money. This is especially true for salaried employees who look for better means to save more of their money.

These income tax exemptions for salaried employees will help them in saving the maximum amount of tax through some more and less common ways. Here’s a list of the most useful income tax exemptions for salaried employees:

1. House Rental Allowance (HRA) 

House Rent Allowance or HRA, is the amount paid by an employer to the employee in order to compensate for the house rent he / she pays. It is paid as a part of your salary and offers you tax benefits along with the obvious compensation for your house rent. A part of the HRA given by an employer to an employee is exempted from Income Tax and while income tax is levied on the remaining part.

HRA Exemption is one of the most useful income tax exemptions for Salaried Employees as it can be easily claimed and the amount of exemption allowed is also large.

For salaried taxpayers, HRA is the first brush with tax savings, the HRA received from the employer qualifies for exemption as long as the employee lives in rented accommodation and pays rent to the owner. The HRA exemption can also be claimed by submitting proof of rent paid to the employer or at the time of filing income tax returns under Section 10(13A). 

The biggest and sufficient benefit of HRA is that it helps in reducing your Taxable Income and thus, helps you in saving Income Tax. Your HRA exemption will be based on the least of the below mentioned options:

  1. The entire amount allotted by the employer as the HRA, in your salary slip.
  2. Actual rent that you pay minus 10% of the basic salary.
  3. 50% of the basic salary, if you’re staying in a metro city (Delhi, Chennai, Kolkata or Mumbai) and 40% if you reside in a non-metro.

As the lowest of the above is exempt from tax, it is common for employers and employees to structure the salary in a manner to avail the maximum tax exemption under this head. 

To understand the impact, assume someone is living in Delhi and earns a basic salary of Rs. 30,000 per month. The HRA component of the salary, in this case, will be Rs. 15,000, but the actual rent paid may be Rs 10,000 or even Rs 20,000. But, the maximum exemption, in this case, will be Rs 84,000 that can be claimed under HRA (See: factors affecting HRA).

Factors affecting HRA calculation 

  1. Actual HRA received is (Rs 15,000 x 12) = Rs 1,80,000
  2. Actual rent paid (Rs 10,000 x 12) – 10% of salary [(Rs 30,000 x 12) x 10%] = Rs 84,000
  3. Actual rent paid (Rs 20,000 x 12) – 10% of salary [(Rs 30,000 x 12) x 10%] = Rs 2,04,000
  4. 50% of basic salary [(Rs 30,000 x 12) x 50%] = Rs 1,80,000

Read More: HRA

2. Transportation Allowance 

Some employers allow their employees transportation allowance. Transportation allowance includes any allowance granted to the employee to meet the cost of travel on tour or on transfer of duty. Broadly speaking, any sum paid for packaging, transfer, and transportation of personal effects of the transfer.

Read More: Transportation Allowance 

3. Leave Travel Allowance

Leave travel allowance is another one of the many allowances allowed by the government to employees that is exempt from the clutches of tax. In some cases, employers give allowances to their employees to go on a trip or a vacation with their families. Do note that the amount given by the employer to an employee for going on a vacation is exempted from tax only to a certain extent provided that the amount given was for a vacation in India only. The income tax exemption on leave travel allowance can be claimed only if the employee actually goes on a vacation as bills for the same would be required to be furnished.

Under LTA, a salaried taxpayer can claim expenses incurred towards domestic vacations such as the expense of travel tickets for the self and even the family. However, the tax exemption doesn’t include costs for the entire trip, like food, shopping and entertainment, among others. 

LTA exemption can be claimed under Section 10(5) of the Income Tax Act, 1961. It is available only for 2 journeys over a period of 4 years. The current block period started in January, 2018 and ends in December, 2021. The law allows you to carry over 1 journey if you didn’t claim it in a previous block. So, if you missed out on claiming two tax exemptions during the last block of 2014-17, then you can carry over one journey to the new block that began from 2018. This means that you can get a maximum of 3 tax exemptions on LTA in a block of 4 years. However, according to Income Tax rules, carry forward is allowed only when you make a claim in the first year of the block. 

Also, remember that LTA tax deductions are considered only for the shortest route to the destination and back. So, in case you’re entitled to an LTA of Rs. 40,000 but have claimed only Rs. 30,000 because that was the cost by the shortest route, the remaining Rs. 10,000 is added to your income and taxed according to your tax slab. 

LTA can be claimed under the following circumstances:

  1. Travel by train: In case your destination of choice is connected by train, the exemption is allowed on a train’s AC first-class tickets
  2. Travel by air:  In case your destination of choice is connected by air, the exemption is allowed on ticket fares of a national airline’s economy class.
  3. Other modes of travel: In case your destination of choice is not connected by air or rail, an amount equivalent to first-class, deluxe, or AC first-class fare, whichever is lower, can be claimed for exemption under LTA.

4. Children Education Allowance

Children education allowance is exempt from tax under the Income Tax Act, 1916. So in case you are getting a children education allowance from your employer then you can easily claim a tax exemption under the law. Do note that the maximum amount exempted from tax is Rs.100 per month or Rs.1,200 per annum for a maximum of up to 2 children. 

Other than this when it comes to the education of your children, you can also claim deductions for the fees paid under Section 80C.

5. Encashment of Leaves

Most employers give all their employees a certain no. of days which can be claimed as leaves. However, in case a person does not claim these leaves, many employers also give their employees the option for en-cashing these leaves i.e. the employers pays extra to the employees for the leaves which were allowed to be taken but were not taken.

This amount received as Leave Encashment is also allowed to be claimed as an exemption up to a certain extent.

Leave encashment comes into play when an employee doesn’t avail the eligible leaves to them, and there is a provision to cash those leaves. This exemption depends on the employer providing this benefit, as some employers allow you to carry forward such leave within limits and do not provide encashment. Many employers who provide for leave encashment do so with limits on the encashment. The amount received as compensation for leave days accumulated is referred to as leave encashment, and it is taxable as salary, but there are conditions when this is tax-exempt to employees. 

Central and State government employees can fully avail leave encashment as it is tax-exempt for them. 

In the case of non-government employees, the least of the following three is exempt.

  1. 10 months average salary preceding retirement or resignation (where average salary includes basic and DA and excludes perquisites and allowances)
  2. Leave encashment actually received. (this is further subject to a limit of Rs 3 lakh for retirements after 02.04.1998)
  3. Amount equal to salary for the leave earned (where leave earned should not exceed 30 days for every year of service)

Let us take the example of a private sector employee who receives Rs 6 lakh as leave encashment at the time of retirement after 25 years with the eligibility of 45 earned leaves every year. 

Eligible number of earned leaves

45 X 25 = 1,125 days

Leaves used

585 during the service period

Leaves eligible for encashment

540 (1125-585)

Average last 10 months basic + dearness allowance

₹25,000

For taxation, the following scenarios emerges

Amount received as leave encashment

₹6 lakh

Maximum cap as stated by government

₹3 lakh

Last 10 months average (Basic + DA) before retirement

₹2.5 lakh

Cash equivalent of the leave balance, subject to maximum of 30 days for each completed year of service

₹1,37,500

Earned leave eligibility = 30 days X 25 = 750 days

Leaves used = 585 days

Leaves eligible for encashment = 750 – 585 = 165 days Cash equivalent = (165/30) X 25000 = ₹1,37,500

Tax exemption

₹1,37,500

Taxable component

₹4,62,500 (₹6,00,000 – ₹1,37,500)

 

6. Income from Gratuity

Gratuity is a gift made by the employer to his employee in appreciation of the past services rendered by the employee. Gratuity can either be received by:-

  1. The employee himself at the time of his retirement

2. The legal heir at the time of the death of the employee

For the purpose of computing Income Tax Exemptions for Salaried Employees who have received gratuity, the employees can be segregated into 3 parts and then the exemption is allowed depending on the category they are into:-

  1. Govt. Employees and employees of Local Authorities

2. Employees covered under the Payment of Gratuity Act, 1972

3. Employees not covered in any of the 2 above.

Gratuity benefits can be claimed by employees at the time of retirement or when they resign after having worked for at least five continuous years for the same employer. It is a financial reward from the employer or gratitude that they receive from the employer for rendering their service to the company for a continuous period. Gratuity is calculated based on two factors – the employee’s last drawn salary and the number of years they have worked in the organization. 

The last drawn salary includes the basic salary and dearness allowance only as all other components to the salary is excluded. The formula for calculating gratuity is simple: multiply the total number of years served with 15 days of salary. 15 days salary is arrived at by dividing the last month’s salary by 26 and then multiplying it by 15. Importantly, gratuity is available to only those employees who are covered by the Payment of Gratuity Act. 

For instance, if your last drawn salary (basic + DA) is Rs 50,000 and you have been employed with the firm for 10 years at the time of resigning or retirement, you will be eligible for Rs 2,88,461 gratuity {(50,000/26X15) X 10}. This entire sum is tax-free as up to Rs 20 lakh gratuity is tax-exempt. 

7. Hostel Expenditure Allowance

Another one of the allowances that comes under the benefit of tax redemption is Hostel Expenditure Allowance. Under the income tax law, any hostel expenditure allowance received by you for your children from your employer is eligible for tax  exemption of up to Rs.300/month or Rs.3,600/annum for a maximum of up to 2 children.

8. Mobile and Internet Reimbursement

You will be glad to know that the Income Tax Act allows employees to claim tax free reimbursement of bills related to mobile and internet. Do note that this reimbursement is on the actual bill amount paid for the mobile and internet or the amount mentioned in the salary package, whichever of the two is lower. However, this one allowance is generally linked to the job description of the employee and is therefore limited.

Well, this concludes our list of income tax exemptions for salaried employees. Hope this helps!

Written by

Priyanshi Bhardwaj