Salary and allowances together form the total compensation an employee receives from an employer for their services. This includes basic salary, bonuses, commissions, and a range of allowances meant to support work-related or personal expenses.
In India, the tax treatment of salary and allowances is governed by the Income Tax Act, 1961. Based on their nature, allowances are classified as taxable, partly taxable, or fully exempt—and each category impacts your final taxable income differently.
Understanding how these allowances are taxed helps employees plan their finances more efficiently and avoid unpleasant surprises at tax time.
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Taxability of various salary allowances
Salary allowances are taxed depending on how they are classified under the Income Tax Act. Broadly, they fall into three categories:
Taxable allowances: Fully added to salary and taxed as per slab rates.
Partly taxable allowances: A portion is exempt, while the remaining amount is taxable.
Fully exempt allowances: Completely exempt from tax if specific conditions are met.
Knowing which allowance falls under which category plays a key role in managing your overall tax liability.
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Taxable allowances
Taxable allowances are fully added to an employee’s gross salary and taxed according to the applicable income tax slab. These allowances do not offer any exemption under the Income Tax Act.
Common taxable allowances include:
Dearness Allowance (DA): Paid to offset inflation and fully taxable.
Overtime Allowance: Given for extra working hours and entirely taxable.
City Compensatory Allowance (CCA): Paid to employees in metro cities and fully taxable.
Entertainment Allowance: Taxable for most employees, with limited deductions for government employees.
Project Allowance: Provided for specific assignments and treated as taxable income.
Since these allowances increase taxable income directly, proper planning becomes important.
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