Is Variable Pay Taxable - How to Save Tax On Variable Pay?

The best way a company can express gratitude to its employees for their contributions is through variable pay. It includes disbursing bonuses, incentives, profit sharing, etc., depending upon their performance and seniority. 

But, as they form a part of your income, you are liable to pay tax on variable pay. Thus, knowing how to avail deductions on your bonuses and reduce your overall tax liability is beneficial. Keep reading to find out! 

What is Variable Pay?

Variable pay also known as performance-linked pay, is extra compensation that employees can earn on top of their regular salary. It’s usually tied to how well they perform individually, as well as how the company is doing overall. This kind of pay often comes in the form of bonuses, commissions, or other incentives, and it's a way for employers to reward hard work and great results.

What are the Different Types of Variable Pay?

The three most common forms are:

Incentive Plan

In this type of arrangement, specific performance targets are set for a particular period, and the payouts are done if the specified criteria are met. Examples of incentive plans include profit sharing, gain sharing, stock options, sales incentives, etc.

Bonus Program

In this case, the payouts are contingent on completing specific tasks and fulfilling related conditions. Examples of bonus programs include retention, referral, and project bonuses.

Recognition Program

Here, broad guidelines are established before implementing the program, and the awards vary based on these guidelines. Examples of recognition programs include spot awards, nomination programs, managerial recognition, etc.

Is Variable Pay Taxable?

Generally, a company calculates variable pay as a percentage of an employee's fixed salary. The range for junior-level employees is typically from 10% to 15%; for mid-level personnel - 15% to 30%; and for seniors, it can be from 30% to 50%.  

Now, the different types of variable income generally get credited to your monthly salary. So, as per IT rules, you are liable to pay tax on variable pay as per your income tax slab. Hence, when you file your Income Tax Returns, they get added to your net taxable income and can increase your payable tax amount. 

Once you estimate your variable pay amount, you can opt for some tax-saving options to reduce your tax liability. 

5 Ways to Save Taxes on Variable Pay

Here are some of the best methods to employ for saving taxes on variable pay:

1. Pay home loan EMIs

If you have a home loan, you can avail tax benefits to reduce your variable pay tax liability. Variable pay is over and above your monthly fixed salary. Paying the one extra EMI over and above the monthly EMIs, immediately upon receipt of variable pay, can help in the reduction of overall interest on loan and also the closure of the home loan before the scheduled duration.

As per Section 80C of the Income Act, you can claim a maximum tax deduction of Rs. 1.5 lakh on the principal amount of the home loan. Moreover, under Section 24, you are liable to tax relief of a maximum of Rs. 2 lakhs under the old tax regime on the interest paid.   

Note:

1. Deduction under section 80C is available only under the old tax regime.
2. The home loan must be availed from a reputed bank or financial institution to avail of this tax benefit. 

2. Make Tax-Saving Investments

Another excellent method to reduce tax on variable pay is to invest in tax-saving schemes, it will be wise to choose them only if you have not exhausted the maximum deductions that one can claim: 

National Savings Certificate (NSC)

Under Section 80C, the NSC principal amount is liable for tax deductions. However, the interest income from this scheme is taxable under the heading "Income from other sources." Experts advise declaring the income earned from this asset annually to reduce your tax liabilities.  

Unit Linked Insurance Plan (ULIP)

The premium amount paid to the insurance part of a ULIP scheme is eligible for tax deduction under Section 80C. Additionally, as per Section 10(10D), you can exclude 1/3rd of the corpus from taxation. 

National Pension Scheme (NPS) 

Investing in the National Pension Scheme (NPS) is an excellent way to reduce your tax liabilities and gain a regular source of income after retirement. Under Section 80C, you can get maximum tax deductions of Rs. 1.5 lakh within a financial year. 

In addition, as per Section 80CCD(1B), you can get an extra Rs. 50,000 deduction on your investment. However, you need to invest in an NPS tier-I account to avail of tax benefits. 

Equity Linked Savings Scheme (ELSS)

Equity Linked Savings Schemes (ELSS) are schemes that invest most of their funds in equity assets. They usually come with a 3-year lock-in period and are an excellent way to gain high returns and tax deductions. Under Section 80C of the Income Tax Act, you can gain tax benefits of up to Rs. 1.5 lakh. 

Public Provident Fund (PPF)

A Public Provident Fund (PPF) is an investment option that belongs to the Exempt-Exempt-Exempt (EEE) category. The minimum and maximum investable amounts are Rs. 500 and Rs. 1.5 lakh respectively within a financial year. As per Section 80C, the maximum tax benefits available are Rs. 1.5 lakh.   

Tax-Saving Fixed Deposits

Another investment vehicle you can use to save tax on variable pay is to open a tax-saving fixed deposit. It comes with a lock-in period of 5 years and offers maximum tax deductions of Rs. 1.5 lakh under Section 80C of the Income Tax Act. 

Sukanya Samriddhi Yojana

If you have a girl child, consider investing in this scheme to save a sizeable corpus for your daughter and avail of tax benefits. It has a horizon of 21 years, and your child needs to be at least 10 years old when you invest in this scheme. 

After your daughter turns 18, you can withdraw up to 50% of the current balance. Under Section 80C of the IT Act, you can avail of a yearly tax deduction of up to Rs.1.5 lakh if you invest in this scheme. 

3. Get a Health Insurance Policy 

Having health insurance cover can help you attain financial coverage along with tax benefits. If you already have one, availing top-up covers special scenarios also helps. According to Section 80D, if you are less than 60 years old, you can get a maximum yearly exemption of Rs. 25,000. You can also claim a tax deduction of Rs. 5,000 by opting for a preventive health check-up. 

If any family member included in the policy is over 60 years old, the tax deduction amount goes up to Rs. 30,000. Furthermore, if you pay policy premiums for your parents, you are liable to get extra tax benefits of Rs. 25,000.

4. Claim Tuition Fee Deductions

You can also avail of tax benefits on the tuition fees that you pay on behalf of your children. This deduction is available for a maximum of two children with a maximum tax relief of Rs.1,200 for each per annum, if the correspondence allowance is part of your salary structure. 

5. Opt For Life Insurance Plan

If you have a life insurance policy, your premium amount is eligible for up to Rs.1.5 lakh tax relief under Section 80C of the Income Tax Act. Moreover, this benefit is available for any life insurance plan.  

Final Word

These were some of the best methods you can implement to reduce your tax payable on variable pay. However, please remember that all these options have their pros and cons. Thus, you must assess your spending capacity and risk tolerance before making a choice.