You’ve probably seen recent media reports about the astronomical salaries of corporate bigwigs. While these numbers are certainly eye-catching, in reality only a small percentage of these salaries actually reach the hands of the earners.
Salaries need to be structured in a manner that increases tax-efficiency, otherwise, a sizeable chunk of one’s income could be lost to taxes.
Additional Reading: Advice For Successful Tax Savings
For example, Mr. X has a salary of Rs 10 lakhs per annum, but only gets Rs. 8 lakhs in hand after paying taxes, due to an inefficient salary structure. On the other hand, Mr. Y earns the same salary of Rs. 10 lakhs but receives a higher amount due to smart salary structuring.
How does this happen? Read on to find out.
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What are the main constituents of salary?
Salary comprises of basic pay, various allowances, provident fund (contributed by the employer), gratuity, and perquisites.
Additional Reading: What Is Basic Salary?
People are often attracted to seemingly handsome salaries that provide a high ‘in-hand’ or basic income, but low allowances and perquisites. Allowances and perquisites should be included in the salary in such a way that it reduces your tax liability significantly.
Basic salary is fully taxable, so if you see this portion of your salary increasing, your tax liability will increase as well. There are certain allowances that are not taxed, up to a prescribed limit. With such allowances in your salary structure, your tax liability will come down. Apart from allowances, there are certain perquisites which also allow tax benefits to some extent.
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Allowances and perquisites that can make your salary tax-efficient
Let’s look at the components vital to a smart salary structure. The objective is to include the maximum number of allowances in your salary structure in order to avail tax deductions.
- Medical bills
Medical bills are the most common expense employees tend to incur. However, if these bills are not included as an allowance in your salary structure, you will not be eligible for any tax deductions. On the other hand, if it is included, you can get an allowance of up to Rs. 15,000 per year as long as you produce genuine bills for the same.
- Vouchers/Coupons
You can get an allowance for meal vouchers/coupons up to Rs. 2,200 per month i.e. Rs. 26,400 per year. You can also use these coupons to buy grocery items.
- House Rent Allowance
The most vital allowance is House Rent Allowance (HRA). You can get tax exemption equivalent to the lowest value of the following:
- Your actual HRA
- 40 or 50 % of basic salary (depending on metro or non-metro city)
- Rent less 10% of basic salary
For example, if your basic salary is Rs. 2 lakhs per year, rent paid is Rs. 1 lakh, and your HRA is Rs. 70,000 a year, then you will get tax deductions on the least of the three, namely:
- 70,000 (actual HRA)
- 1 lakh (50% of basic salary)
- 80,000 (rent minus 10% of basic salary)
So, the tax deduction would be allowed for Rs. 70,000 in this case. Remember, if you live in your own home, keep your HRA as low as possible.
- Children’s Education
You can claim a deduction for child education allowance up to Rs. 2,400 per year for up to 2 children (Rs. 100 each child).
- Other Allowances
Spending on newspapers and books are also allowed as an allowance. Similarly, there are many other allowances such as Leave Travel Allowance (LTA), fuel reimbursement, telephone allowance, conveyance allowance, etc., that you can pick based on your actual requirement and include under your salary structure for tax benefits.
| Planned Salary Structure Vs Unplanned Salary Structure | |||
| CASE A (In Rs.) |
CASE B (In Rs.) |
||
| Basic Salary | 500,000 | 500,000 | |
| Flexible/Unplanned Allowance (Taxable) | 258,400 | ||
| Planned Allowances/ Reimbursements (Tax Exempted) | |||
| HRA | 200,000 | ||
| Medical Reimbursement | 15,000 | ||
| Meal Voucher (Up to Rs 50/meal twice a day for 22 days) | 26,400 | ||
| Gift Voucher | 5,000 | ||
| Books and periodicals (Rs 1000 per month) | 12,000 | ||
| CTC | 758,400 | 758,400 | |
| a | Taxable Salary | 500,000 | 758,400 |
| b | Investment under U/s 80 (C) of IT Act | 150,000 | 150,000 |
| c | Investment in NPS U/s 80 CCD (1B) of IT Act | 50,000 | 50,000 |
| a-b-c | Gross Taxable Amount | 300,000 | 558,400 |
| Less exempted income under IT Act (Up to Rs. 2.5 lakhs) | 250,000 | 250,000 | |
| Net taxable amount | 50,000 | 358,400 | |
| A | Tax @ 10% | 5,000 | 25,000 |
| B | Tax @ 20% | 21680 | |
| C | Less: Rebate U/S 87 A of I-T Act | 5000 | |
| A+B-C | Net Tax Payable | NIL | 46680 |
| *All figures are assumed and for simplicity in understanding education cess has not been imposed. Assumptions as per A.Y 2017-18. In case II, it’s assumed that no allowance benefits are taken. | |||
As analysed in the table above, a planned salary structure can save you a substantial amount on tax. You can include many others allowances in accordance to your actual requirements, but don’t forget to keep records of all your bills and payments while claiming allowances for various purposes.