Section 16 of the Income Tax Act, 1961, is an important section that provides details about the standard deduction, professional tax, and entertainment allowance. The standard deduction is one of the most basic and important deductions that lowers a taxpayer's taxable income. Taxpayers in India are different as some may be earning individuals while others may be retired without any primary source of income.
As the income tax rules are extensive and different for everyone, it is vital that you understand the important sections of the Income Tax Act of 1961 that may allow you to lower your taxable income and save tax. This article will help you understand section 16 of the Income Tax Act, 1961, and how it can help you increase your savings by avoiding unnecessary taxes.
What is section 16 of the Income Tax Act?
Section 16 of the Income Tax Act (ITA), 1961 outlines the deductions available under the "Salaries" head, which help lower the taxable income of salaried individuals, thereby reducing their overall tax liability.
This section allows deductions for professional tax, entertainment expenses, and a standard deduction. Salaried individuals who incur professional taxes can claim these deductions to reduce the taxable portion of their salary, ultimately decreasing the amount of income subject to taxation.
The standard deduction, a fixed amount deducted from taxable salary, helps reduce the overall tax burden. Professional tax is also deductible under this section, allowing individuals to claim relief on the tax paid to state governments. Additionally, the entertainment allowance is available as a deduction for government employees. These provisions together significantly lower the taxable income, enabling taxpayers to minimise their tax liabilities, thereby encouraging compliance and reducing financial strain.
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Deductions under section 16
Section 16 of the Income Tax Act 1961 offers three key deductions that help taxpayers reduce their taxable income. These deductions are designed to benefit salaried individuals by lowering their overall tax liability. The three deductions under Section 16 are as follows:
- Standard Deduction (Section 16[ia]): This allows salaried employees to claim a fixed deduction from their gross salary, reducing their taxable income directly.
- Entertainment Allowance (Section 16[ii]): Government employees can claim a deduction on the entertainment allowance they receive, subject to certain conditions. This deduction provides additional tax relief.
- Professional Tax (Section 16[iii]): This allows individuals to claim a deduction for the professional tax paid to their respective state governments. Professional tax is levied by the state, and this provision ensures that the amount paid can be deducted from the salary income.
Understanding and utilising these deductions can significantly reduce your tax liability, helping you save on taxes when filing your Income Tax Returns (ITR).
Standard deduction under section 16(ia)
The Income Tax Act of 1961 allows a standard deduction of Rs. 50,000 that is directly levied on the gross salary while filing an ITR. Earlier, the standard deduction was only available in the old regime but was introduced in the new regime during the Union Budget 2023. Now, taxpayers filing taxes in both the new and old regimes can utilise the standard deduction of Rs. 50,000, effectively lowering the taxable income by the same amount.
Every financial year, you can utilise section 16 of the Income Tax Act to claim the standard deduction on the lower amount between the following two:
- Your actual salary amount
- Rs. 50,000 (from AY 2020-21)
For example, if your gross salary is Rs. 7 lakh (higher than Rs. 50,000), you will find the standard deduction automatically utilised while filing taxes. As it is available for everyone, it is levied directly and will lower your taxable income to Rs. 6.5 lakh automatically. You can claim this deduction irrespective of your actual spending. The government introduced the standard deduction in place of medical and transport allowance.
Here is a table for a better understanding of the standard deduction:
| Component | Old tax regime | New tax regime |
| Annual salary | Rs. 8,00,000 | Rs. 8,00,000 |
| Standard deduction | Rs. 50,000 | Rs. 50,000 |
| Other deductions (80C, 80D) | Rs. 1,50,000 | Nil |
| Taxable income | Rs. 6,00,000 | Rs. 7,50,000 |
| Tax calculation | ||
| Up to Rs. 2,50,000 | Nil | Nil |
| Rs. 2,50,001 to Rs. 5,00,000 | Rs. 12,500 (5% of Rs. 2,50,000) | Rs. 12,500 (5% of Rs. 2,50,000) |
| Rs. 5,00,001 to Rs. 7,50,000 | Rs. 20,000 (10% of Rs. 2,00,000) | Rs. 25,000 (10% of Rs. 2,50,000) |
| Total tax payable | Rs. 32,500 | Rs. 37,500 |
| Education cess 4% | Rs. 1,300 | Rs. 1,500 |
| Total tax liability | Rs. 33,800 | Rs. 39,000 |
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Who is eligible for deduction under Section 16(ia)?
Under Section 16(ia) of the Income Tax Act, all salaried individuals are eligible for the standard deduction, regardless of whether they work in the government or private sector, or are employed as a regular worker, pensioner, or professional earning a salary. This benefit is available to a wide range of individuals receiving salary income.
The following groups of people can claim the standard deduction under Section 16(ia):
- Employees: Individuals working in government, private companies, or public sector enterprises can benefit from this deduction.
- Pensioners: Retired individuals receiving a pension from their former employer are also eligible for the standard deduction on their pension income.
- Professionals: Self-employed professionals, such as doctors, lawyers, engineers, consultants, and others who receive a salary, are entitled to claim this deduction under Section 16(ia).
Entertainment allowance under section 16(ii)
The entertainment allowance under section 16 of the Income Tax Act is initially included under the ‘Salaries’ head while filing the ITR. Afterwards, a deduction is provided based on the following factors:
In the case that the taxpayer is a government employee of the central or the state government, the minimum amount from the following is available as the entertainment deduction:
- 20% of the basic salary
- Rs. 5,000
- The actual entertainment allowance received during the last year
The following factors are considered while calculating the entertainment allowance:
- The basic salary, in this case, excludes the alliance, benefits, and any other perquisites.
- The actual amount that is spent on entertainment out of the entertainment allowance received is not considered.
- The entertainment allowance is calculated based on the received allowance amount and not the actual amount spent.
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If the taxpayer is a non-government employee (including employees working in statutory corporations and local authorities)
If the taxpayer is not a government employee, no deduction is available for entertainment allowance under section 16 of the Income Tax Act. Even if such non-government employees receive entertainment allowance from their employer, the whole amount is added to their taxable salary and taxed at their applicable income tax slab rate.
Professional tax/tax on employment under section 16(iii)
Professional tax, or tax on employment, is levied by some Indian states, and the taxpayers can utilise a deduction for the same under section 16 of the Income Tax Act. Here are the factors that affect the professional tax and its deduction:
- Taxpayers can claim a deduction for professional tax only in the year when the professional tax is actually paid.
- The state governments can charge a maximum of Rs. 2,500 as professional tax. The entire professional tax paid is eligible for deduction.
- If an employer pays professional tax on behalf of an employee, it is shown under the ‘perquisite’ section in the employee salary structure. The amount equal to the tax paid is eligible for deduction under the ‘professional tax’ head of the salary.
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Deductions under Section 16 under the new regime
Under the new tax regime, only section 16(ia) is available, which provides a standard deduction of Rs. 50,000 to the taxpayers. This means that the taxpayers who choose the new regime can lower their taxable income by Rs. 50,000 automatically. However, the other two deductions—entertainment allowance under section 16(ii) and professional tax deduction under section(iii)—are not available in the new tax regime.
Benefits of Section 16
Here are the benefits of section 16 of the Income Tax Act:
Reduced taxable income
One of the most important benefits of section 16 is that taxpayers can significantly reduce their taxable income. The most basic standard deduction (available in the new and the old regimes) automatically lowers the taxable income by Rs. 50,000. If the taxpayer is a government employee, the taxable income can be further lowered by claiming an entertainment allowance. Furthermore, if the state government has charged professional tax, a deduction is available in the old regime, which can reduce the taxable income.
Simplified tax filing
Earlier, taxpayers had to furnish receipts for medical and transport allowance to claim deductions under section 16, which was time-consuming. Now, the new deductions under section 16 of the Income Tax Act are covered by the standard deduction, which applies automatically without the need to furnish receipts, simplifying tax filing.
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How does standard deduction impact pensioners?
The pension that a retired individual receives from former employers is included under the ‘Salaries’ head while filing the ITR. Thus, like other taxpayers, pensioners can also claim the standard deduction of Rs. 50,000 on the actual pension amount received in a financial year or Rs. 50,000 (whichever is less). The standard deduction positively impacts pensioners as they don’t have to pay a higher tax amount and can utilise it, as most pensioners do not get medical or transport allowances in their pensions.
How can you claim a standard deduction?
Claiming the standard deduction under Section 16 of the Income Tax Act of 1961 is a simple process, although the procedure may differ depending on whether you file online or offline.
Typically, if you are a salaried employee, your employer will include the standard deduction when calculating the Tax Deducted at Source (TDS) from your salary. This amount should be reflected in the Form 16 issued by your employer. However, if the deduction is not applied, you can claim it while filing your income tax return.
Note that the standard deduction is available only to salaried individuals or pensioners filing under the old tax regime (not under the new tax regime, Section 115 BAC).
- For online filing: When filing your income tax return online, the standard deduction is automatically accounted for by the e-filing platform. You don't need to manually enter it or submit any additional documents.
- For offline filing: If you're filing offline, complete the appropriate tax return form (e.g., ITR-1, ITR-2, etc.) based on your income category. In the section for deductions under Section 16, specify the standard deduction amount, which is Rs. 50,000 or your actual salary, whichever is lower. While you don't need to submit documents specifically for the standard deduction, be sure to retain your Form 16 and other income-related documents for your records.
What is the need for section 16 of the Income Tax Act (ITA), 1961?
Here are the points that showcase the need for section 16 of the Income Tax Act:
Equity and fairness
Section 16 recognises that salaried individuals incur expenses such as professional tax and entertainment spending, which should be a part of their salary structure and not the expenses they should pay from their own pockets. Hence, section 16 allows taxpayers to claim deductions on such expenses, ensuring a fair tax burden. The standard deduction helps taxpayers utilise a tax deduction of Rs. 50,000 without furnishing expense receipts, further simplifying the tax filing and deduction-claiming process.
Promotes economic activity
Deductions available under section 16 allows taxpayers to lower their taxable income, resulting in the payment of a lower tax amount. The lower tax liability increases the savings and allows for a higher disposable income in the taxpayers’ hands. A higher disposable income can create a higher spending potential, which promotes economic activity. It also increases employee retention as more salaried individuals find the deductions attractive for increasing their overall savings.
Administrative efficiency
Deductions under section 16 are among the most simplified, as they don’t require extensive paperwork, making tax calculations simple for both tax authorities and taxpayers. Furthermore, there are fewer disputes between taxpayers and tax authorities as the biggest deduction of Rs. 50,000 is flat without the need for any expense receipts or other claims.
Encourages compliance
Section 16 deductions make the overall tax system straightforward and user-friendly, and taxpayers do not hesitate to claim the included deductions. This encourages tax compliance and ultimately increases the tax amount collected by the government, which can be used for developmental activities.
Key takeaways
- Section 16 of the Income Tax Act provides details about three deductions: the standard deduction, the entertainment allowance deduction, and the professional tax deduction.
- The standard deduction was Rs. 40,000 until 2019 but is now Rs. 50,000. This deduction is available in both the new and old tax regimes.
- The entertainment allowance is only available for government employees and is either up to Rs. 5,000 or one-fifth of the salary, whichever is lower.
- Some Indian states levy professional tax, and the tax amount can be claimed as a deduction under section 16.
Conclusion
Section 16 of the Income Tax Act is an important section that outlines three deductions: standard deduction, entertainment allowance, and professional tax deduction. If you are a taxpayer, you can utilise these deductions under section 16 to lower your taxable income by a hefty margin and avoid paying unnecessary taxes. The tax-saving can allow you to increase your savings and have a higher disposable income, which you can use for various other expenses to improve your standard of living.
