Income From Salary – How To Calculate Income Tax On Salary With Example (AY 2025-26)

Salary constitutes significant income for most of middle income tax payers. It includes and excludes a lot of components such as basic pay, allowances, perquisites, variable pay and so on. Besides, various deductions and exemptions can be claimed against allowances and perquisites, reducing the tax implications. 

TDS is deducted on salary income by the employer, based on income estimations made in the beginning of the financial year. If excess TDS is deducted, refund can be claimed while filing ITR. On filing, the taxpayer still has the option to choose the best regime for them, old or new. 

This article talks about structure of your salary, various deductions and exemptions available against allowances and perquisites, retirement benefits taxability, tax slabs, and illustrations of tax calculations. 

What is Salary?

Any compensation or benefit received by the employee from his employer falls under the purview of salary. This need not be received in cash. More often than not, non monetary benefits the employee receives forms part of their salary. The meaning of salary might differ for accounting, taxation and other laws. So, the meaning provided above holds good for general understanding of salary income. 

Definition and Scope

The definition of salary is covered under section 17(1) of the Income Tax Act. The definition provided is inclusive in nature, which means that the components not covered under this definition may also be considered a part of salary, based on facts and circumstances of the case. As per section 17, salary includes the following:

• Basic pay
• Allowances, which includes House Rent Allowance (HRA), Leave Travel Allowance (LTA), Children Education Allowance, Special Allowances, etc.
• Perquisites - benefits received in terms of kind like accommodation, commute expenses, lunch, etc.
• Variable pay (or) performance bonus - is a part of taxable salary
• Leave encashment - consideration for leave days worked
• Pension or Annuity;
• Gratuity;
• Salary advance provided
• Compensation received on termination (or) for modification of employment contract
• Other fees, commission, as a part of employment contract
• Taxable part of employer's contribution to provident fund.

Components of Salary

Basic Salary

• This is a fixed component in your paycheck and forms the basis of other portions of your salary, hence the name. 
• For instance, HRA is defined as a percentage (as per the company’s discretion) of this basic salary. 
• Your PF is deducted at 12% of your basic salary. It is usually a large portion of your total salary.

House Rent Allowance (HRA)

• Salaried individuals, who live in a rented house/apartment, can claim House Rent Allowance or HRA to lower taxable income. This can be partially or completely exempt from taxes. 
• The Income Tax laws have prescribed a method for computing the HRA that can be claimed as an exemption.
• This exemption is applicable only under the old regime, in the new tax regime, HRA cannot be claimed.
• If you receive HRA or don’t live on rent, your HRA shall be fully taxable.
• If you live with your parents, you can still claim HRA exemption. Ensure you enter into a renal agreement with your parents, make rent payment to your parents via bank and maintain proper record of rental receipts.
• However, this rent will be considered as house property income of parents. Consider these implications and do tax planning accordingly. 

Leave Travel Allowance

• Salaried employees can avail exemption for a trip within India under Leave Travel Allowance. The exemption is only for the shortest distance on a trip. 
• This allowance can only be claimed for a trip taken with your spouse, children, and parents, but not with other relatives. 
• This particular exemption is up to the actual expenses, therefore unless you actually take the trip and incur these expenses, you cannot claim it. Submit the bills to your employer to claim this exemption.

Bonus

• The bonus is usually paid once or twice a year. Bonus, performance incentive, variable pay, whatever may be its name, is 100% taxable. 
• Performance bonus is usually linked to your appraisal ratings or your performance during a period and is based on the company policy.

Employee Contribution to Provident Fund (PF)

• Provident Fund or PF is a social security initiative by the Government of India. This is a retirement benefit that companies with over 20 employees must provide as per the EPF Act, 1952.
• Both employer and employee contribute a 12% equivalent of the employee’s basic salary every month towards the employee’s pension and provident fund. 
• The current EPF interest rate remains unchanged at 8.25%. However, the TDS rate for taxable EPF withdrawals is 20% for non-PAN holders. 

Professional Tax

• Professional tax or tax on employment is a tax levied by the respective states, just like income tax which is levied by the central government. Rates for professional tax is fixed by the respective states.
• The maximum amount of professional tax that can be levied by a state is Rs 2,500 per annum. It is usually deducted by the employer and deposited with the state government. 
• In your income tax return, professional tax is allowed as a deduction from your salary income under the old tax regime only.

Difference between Take Home Salary and CTC

Your job may entitle you to some benefits in the form of food coupons or a cab service apart from your salary. The total Cost To the Company (CTC) is the sum of all the benefits offered plus your salary. 

However, your take home salary is the amount after applicable deductions that gets credited to your bank account.Let us understand this with an example. 

Broadly your CTC will include:

a. Salary received each month.

b. Retirement benefits such as PF and gratuity.

c. Non-monetary benefits such as an office cab service, medical insurance paid for by the company, free meals at the office, a phone provided to you and bills reimbursed by your company.

Your take-home salary will include:

a. Gross salary received each month.

b. Minus: Provident fund deduction, Medical insurance deduction

c. Minus: Income taxes payable (calculated after considering Section 80 deductions).

Tax Benefits for Salary Income 

There are various deductions offered under chapter VI-A, applicable for all the general income (income for which no special rates of taxes are levied,and taxed under slab rates). However there are certain deductions and exemptions that are specifically available to salary income. Read more to know about various tax benefits available for salary income.

Deductions available against Slab Rate Income

Section 80C - Investment Deductions

• Prescribed mode of investments as mentioned under section 80C can be claimed as a deduction subject to a maximum limit of Rs. 1.5 lakhs.
• However, this deduction can be claimed only under the old regime.

Section 80D - Medical Insurance

• Premium paid to medical insurance can be claimed as a deduction up to Rs.25,000 for self and family, and Rs.50,000 in case of senior citizens.
• Similarly, you can claim deduction on premium paid to parents. Rs.50,000 for senior citizens and Rs.25,000 for others. 
• This deduction is also restricted to the old regime.

Section 24 - Home Loan Interest

• Under section 24, if you have let out your house on rent, interest on that home loan can be claimed fully  irrespective of whether it is paid or not.
• If you live in the house, interest on that home loan is restricted to a ceiling limit of Rs. 2 lakhs.
• Deduction for let out house property is available under both old and new regime, whereas, deductions for self occupied roperty is available only under the old regime.

Section 80CCD - Pension Contribution

• National Pension System is a long term retirement savings scheme launched by Pension Fund Regulatory Authority of India.
• If a salaried employee opts this retirement scheme, both employers and employees themselves contribute under this scheme. And deduction can be claimed on both of the contributions, while certain restrictions apply.
• For employers contribution, deduction up to a ceiling limit of 14% of their basic salary can is available under section 80CCD, irrespective of regime chosen.
• For employees (their own) contribution, you can claim deduction under section 80C and 80CCD(1B), up to Rs. 2 lakhs.

Exclusive Deductions available on Salary Income

 Standard Deduction

• Standard deduction refers to the fixed amount of deduction available against salary income, with no pre-requisites attached.
• Presently, standard deduction of Rs. 50,000 is available under old tax regime and Rs.75,000 is available under new tax regime u/s 115 BAC.

Exemption of Leave Encashment

• Leave encashment refers to the compensation received by the employee for the leave days worked, forming part of salary income. 
• Deduction can be claimed on leave encashment irrespective of regime chosen.
• Exemption of leave encashment from tax:
  • Fully exempt for Central and State government employees. 
  • For non-government employees, the least of the following is exempt.
    • 10 months average salary preceding retirement or resignation (where average salary includes basic and DA and excludes perquisites and allowances).
    • Leave encashment received
    • Amount equal to salary for the leave earned (where leave earned should not exceed 30 days for every year of service)
    • Rs.25 lakhs

Relief on Arrear / Advance Salary

You are allowed tax relief under Section 89(1) when you have received a portion of your salary in arrears or in advance or have received a family pension in arrears.

Calculate the Tax Relief Yourself

Step-1: Calculate the tax payable on the total income, including additional salary in the year it is received.

Step-2 :Calculate the tax payable on the total income, excluding additional salary in the year it is received

Step-3: Calculate the difference between Step 1 and Step 2.

Step-4: Calculate the tax payable on the total income of the year to which the arrears relate, excluding arrears.

Step-5:Calculate the tax payable on the total income of the year to which the arrears relate, including arrears

Step-6:Calculate the difference between Step 4 and Step 5

The excess amount at Step 3 over Step 6 is the tax relief that shall be allowed.

Note:  The amount at Step 6 is more than the amount at Step 3, no relief shall be allowed.

Exemption on Receipts at the Time of Voluntary Retirement

Any compensation received on voluntary retirement or separation is exempt from tax as per Section 10(10C). Maximum exemption of Rs.5,00,000 is allowed. The following conditions need to be satisfied for claiming this exemption:

1. The recipient is an employee of an authority established under the Central or State Act, local authority, university, IIT, state government, or central government, notified institute of management, or notified institute of importance throughout India or any state, PSU, company, or cooperative society.
2. The receipts comply with Rule 2BA.

Note: 

• Exemption can only be claimed in the assessment year the compensation is received.
• If the assessee has already claimed relief under section 89, treating the compensation received as arrear salary, exemption under this section cannot be claimed on the year of receipt of compensation.

Pension

• Pension is taxable under the head salaries in the income tax return. Pension is paid out periodically monthly usually. 
• You may also choose to take a pension as a lump sum (also called a commuted pension) instead of a periodical payment. 
•  For a government employee, a commuted pension is fully exempt. Uncommuted pension or any periodical payment of pension is fully taxable as salary.
• For a non - government employee, taxation of commuted pension depends on whether he receives gratuity or not.
  • If gratuity is also received with a pension – 1/3rd of the total amount of pension is exempt, and the remaining is taxed as salary. 
  • If only the pension is received, gratuity is not received, then ½ of the total amount of pension is exempt.
• This exemption is allowed irrespective of regime chosen.

Gratuity

• Gratuity is a retirement benefit that employers provide for their employees. 
• The employee is entitled to receive gratuity when he completes five years of service at that company. It is, however, only paid on retirement or resignation. 
• Gratuity received on retirement or death by a central, state or local government employee is fully exempt from tax for the employee or his family. 
• The tax treatment of your gratuity is different, depending on whether your employer is covered by the Payment of Gratuity Act. Check with your company about its status, and then proceed to calculate.
• The maximum ceiling limit is determined based on whether the gratuity is covered under the gratuity act or not. However, the exemption cannot exceed Rs. 20 lakhs. This is irrespective of you choosing old or new tax regime.

Tax calculation on Salary Income

We have seen the meaning, components, and tax deductions available under the salary. Let us now understand the taxation part, how to calculate income for taxable salary.

Step-1: Determining Income Chargeable to Tax

Your income is not equal to your salary. You could earn income from several other sources other than your salary income. Your total income, according to the income tax department, could be from house property, profit or loss from selling stocks or from interest on a savings account or on fixed deposits, divided under 5 heads as per the Income Tax Act. Total all the income from various heads, and reduce the applicable deductions. You will arrive at taxable income.

Step-2: Tax Rates

Income for individuals are taxed under normal slab rates. However, there are certain income taxable under special rates. For example, capital gains , online gaming income, etc.  

ClearTax’s app lets you determine your tax refund or dues for the year. The income tax slab rates under old and new tax regimes or FY 2024-25  and FY 2025-26 are given below:

New Regime Slab Rates FY 2024-25

• Up to Rs. 3 lakh - NIL
• Rs. 3 lakh - Rs.7 lakh - 5%
• Rs. 7 lakh - Rs. 10 lakh - 10%
• Rs. 10 lakh - Rs. 12 lakh - 15%
• Rs. 12 lakh - Rs. 15 lakh - 20%
• Above Rs. 15 lakh - 30%

New Regime Slab Rates FY 2025-26

• Rs. 0 to Rs. 4 lakh – Nil, 
• Rs. 4 lakh to Rs. 8 lakh – 5%
• Rs. 8 lakh to Rs. 12 lakh – 10% 
• Rs. 12 lakh to Rs. 16 lakh – 15% 
• Rs. 16 lakh to Rs. 20 lakh – 20% 
• Rs. 20 lakh to Rs. 24 lakh – 25% 
• Above Rs. 24 lakh - 30%

Old Regime Slab Rates FY 2025-26 & FY 2024-25

• Individuals less than 60 Years of Age
  • Up to Rs. 2.5 lakh - NIL
  • Rs. 2.5 lakh - Rs. 5 lakh - 5% 
  • Rs. 5 lakh - Rs. 10 lakh - 20%
  • Above Rs. 10 lakh - 30%
• Resident Individuals Aged 60-80 Years
  • Up to Rs. 3 lakh - NIL
  • Rs. 3 lakh - Rs. 5 lakh - 5% 
  • Rs. 5 lakh - Rs. 10 lakh - 20%
  • Above Rs. 10 lakh - 30%
• Resident Individuals Aged more than 80 Years
  • Up to Rs. 5 lakh - NIL
  • Rs. 5 lakh - Rs. 10 lakh - 20%
  • Above Rs. 10 lakh - 30%

Note:

• For FY 2024-25 – 
  • Health and Education Cess is 4% of the sum of total income tax and surcharge.
  • Rebate of Rs.25,000 is allowed when the total taxable income does not exceed Rs. 7 lakhs under new regime
  • Under the old regime, Rs.12,500 rebate is allowed when the total income does not exceed Rs. 5 lakhs.
• For FY 2025-26 - The Rebate limit under Section 87A has been increased to Rs. 12 Lakhs under the New Tax Regime. Up to Rs. 60,000 of rebate is allowed.

TDS on Salary

• TDS is tax deducted at source. 
• Your employer deducts a portion of your salary every month and pays it to the income tax department on your behalf. 
• Based on your total salary for the whole year and your investments in tax-saving products, your employer determines the tax liability for the year and how much TDS has to be deducted from your salary each month.
• For a salaried employee, TDS forms a major portion of an employee’s income tax payment. 
• Your employer will provide you with a TDS certificate called Form 16 typically around June or July showing you how much tax was deducted each month.

Salary Income - Documents Required for Filing ITR 

Form 16

• Form 16 is a TDS certificate. The income tax department mandates all employers to deduct TDS from their salary and deposit it with the government. 
• The Form 16 certificate contains details about the salary you have earned during the year and the TDS amount deducted.
• It has two parts 
  • Part A  - with details about the employer and employee name, address, PAN and TAN details, and TDS deductions.
  • Part B - includes details of salary paid, other incomes, deductions allowed, and tax payable.

Did you know that Form 16 is all you need to e-file your income tax returns on ClearTax?

Form 26AS

• Form 26AS is a summary of taxes deducted on your behalf and taxes paid by you. This is provided by the Income Tax Department. 
• It shows details of tax deducted on your behalf by deductors, details on tax deposited by taxpayers, and tax refunds received in the financial year. This form can be accessed from the IT Department’s website.

Annual Information Statement (AIS)

Annual Information Statement is a summary of all the financial transactions reported with the income tax department it includes information like

1. Income from Salary, Interest on SB/FD/RD
2. Capital gains on the sale of mutual funds or stocks
3. Sale of immovable property as reported by sub-registrar 
4. Purchase of FD, Mutual fund, stocks, Immovable property
5. Foreign remittance 
6. Cash deposits exceeding the limit of Rs. 10 lakhs in a year
7. Credit Card payments exceeding the limit of Rs.10 lakhs in a year
8. Tax Payment details - Self-assessment tax, Advance tax
9. Tax Refund details

It is very important to verify the details in Form 26AS and AIS before you file your Income tax return. Any mismatch in AIS or Form 26AS against your ITR will lead to a notice.

Conclusion

Taxpayers having Income from Salary have various exemptions and deductions that they can claim to reduce their taxable income. However, most of these exemptions and deductions are limited only to the old tax regime. Hence, it is important for taxpayers to understand their salary structure and decide the appropriate tax regime to optimise maximum tax savings.