Salary Income in India: How It Is Taxed Under the Income Tax Act 2025

When your employer pays you, part of what you receive may not count as salary under the law, and part of it may not be taxed at all. The Income Tax Act 2025 uses Sections 15, 16 and 17 to draw this line. Here is exactly what each section covers and how it affects the tax you owe.

What is salary income?

Section 15 of the Income Tax Act 2025 puts salary income on the tax map. It covers:

Pay from an employer for services rendered
Wages, fees, commissions
Any amount due or received from current or past employment

The income is taxable in the financial year in which you receive it (cash basis) or in which it becomes due, whichever is earlier.

Section 17 — what counts as salary

Section 17 defines salary broadly. It has three parts.

Allowances (Section 17(1))

An allowance is a regular payment your employer adds to your basic pay. Not all allowances are taxed the same way. Some are fully taxable. Some are partly exempt. Some are fully exempt.

The most common allowances and their tax treatment under the new regime are:

Allowance	Tax treatment under new regime
Basic pay	Fully taxable
Dearness allowance (DA)	Fully taxable
House Rent Allowance (HRA)	Partially exempt — see Section 10(13A) and our HRA exemption guide
Transport allowance	Up to ₹3,200 per month exempt (Section 10(14))
Conveyance allowance	Exempt if for commuting to office
Medical allowance	Exempt up to ₹15,000 per year if spent on medical treatment
Overtime allowance	Fully taxable
Special allowance	Fully taxable

Perquisites (Section 17(2))

A perquisite is a benefit your employer gives you in a form other than cash. The Income Tax Act 2025 lists the main perquisites in Section 17(2).

Common examples:

Rent-free or concessionally-rented accommodation — the differential between market rent and what you pay is taxable
Car provided by employer — taxable based on engine capacity and whether it is for personal use
Club memberships — annual fees paid by employer are taxable
Insurance premium paid by employer — the amount is taxable as a perquisite
Interest-free or low-interest loans — the interest differential is taxable
Shares or stock options — taxable at exercise or vesting (rules changed in the 2025 Act)
Credit card fees — annual fees paid by employer are taxable
Health club / gym — employer-paid memberships are taxable

The market value of the perquisite is added to your salary. Your employer is required to report the value of each perquisite in your Form 16.

Exempt perquisites — some employer-provided benefits are not taxed:

Refreshments in office
Books and journals for work
Telephone at residence
Computer or laptop for personal use (from AY 2025-26)
Accident insurance policy
Employer contribution to EPF (up to 12% of salary, if covered by the Pension Act)

Profits in lieu of salary (Section 17(3))

Section 17(3) covers any payment you receive from your employer that is not a salary but is made in connection with your employment. Common examples:

Gratuity — received on retirement or death. Tax treatment depends on the Payment of Gratuity Act coverage and the limit under Section 10(10). Under the Income Tax Act 2025, the exempt portion is the least of: the actual amount received, 15 days salary for each year of completed service, or ₹20,00,000.
Commuted pension — a lump sum received in exchange for giving up part of your pension. Fully exempt if you are covered by the Payment of Gratuity Act and receive a commuted pension. Otherwise, 1/3 of the commuted value is exempt and 2/3 is taxable.
Leave encashment — on retirement or resignation. Under the Income Tax Act 2025, leave encashment for a salaried employee is exempt up to ₹25,00,000 (this limit applies regardless of whether you are covered by the Payment of Gratuity Act).
Retirement benefits — any voluntary separation compensation, voluntary retirement scheme (VRS) payout — taxable as profits in lieu of salary.

Section 16 — deductions from salary income

Section 16 gives specific deductions that apply only to salary income. These are available under both regimes, but are most relevant if you are still on the old regime (where they reduce taxable income) or if you are computing income under the new regime (where some may still apply as a rebate).

The three deductions under Section 16 are:

Section 16(i) — Standard deduction. The Income Tax Act 2025 sets the standard deduction at ₹75,000 per year for all salaried employees. This amount is subtracted from your gross salary before tax is calculated. It is available under both the old and new regimes. It replaced the old conveyance and medical allowances.

Section 16(ii) — Professional tax. Tax paid to a state government under a state profession tax law is deductible. This is not a deduction from income — it is deducted from the tax payable itself. The maximum deductible amount is ₹2,500 per year. Note: this deduction is not available under the new regime.

Section 16(iii) — Entertainment allowance. An allowance paid specifically for professional purposes. Under the Income Tax Act 2025, this is deductible only for government employees. Private sector employees cannot claim this deduction.

How salary is taxed under the new regime

The new tax regime (Section 202 of the Income Tax Act 2025) makes salary income part of your total income. All income from every source — salary, house property, capital gains, other sources — is added together. Then the standard deduction of ₹75,000 is applied. Then the slabs are applied.

This means under the new regime:

Gross salary = all allowances + all perquisites + all profits in lieu of salary
Less: standard deduction (Section 16(i)) = ₹75,000
Less: professional tax paid (Section 16(ii)) = up to ₹2,500 (reduces tax, not income)
= Taxable salary income
Add: income from other sources
= Gross total income
Apply new regime slabs

Under the new regime, no specific salary-only deductions apply. The standard deduction handles the old allowance exemptions in a single sweep.

What employers report — Form 16

Your employer deducts TDS under Section 192 of the Income Tax Act 2025 and issues Form 16 at the end of the financial year. Form 16 contains:

Your gross salary
All allowances and their exempt portions
The value of all perquisites
All profits in lieu of salary
The standard deduction applied
Professional tax deducted
Section 80C, 80D, 80CCD(1B) and other deductions your employer knows about (if you submitted proof)
TDS amount

Form 16 is the document banks ask for when you apply for a home loan or car loan. Keep it safe.

Worked examples

Example 1 — ₹9 lakh per year, new regime:

Basic + DA: ₹7,20,000
HRA (actual): ₹2,16,000 (HRA exempt portion depends on rent paid — assume ₹1,00,000 exempt under Section 10(13A))
Transport allowance: ₹38,400 (₹3,200/month × 12)
Conveyance: ₹19,200 (exempt)
Medical from employer: ₹15,000 (fully exempt)
Standard deduction: ₹75,000

Gross salary: ₹10,08,800
Less exempt allowances: ₹1,15,200
Less standard deduction: ₹75,000
Taxable salary: ₹8,18,600

Slabs under new regime FY 2026-27:

Up to ₹4,00,000: ₹0
₹4,00,001 to ₹8,00,000: 5% of ₹4,00,000 = ₹20,000
₹8,00,001 to ₹8,18,600: 10% of ₹18,600 = ₹1,860

Tax before rebate: ₹21,860
Section 87A rebate (income below ₹12 lakh): ₹21,860
Tax after rebate: ₹0
Cess: ₹0
Final tax: ₹0

Example 2 — ₹18 lakh per year, new regime:

Basic + DA: ₹14,40,000
HRA: ₹4,32,000
Special allowance: ₹1,44,000
Perquisite (car): ₹96,000
Standard deduction: ₹75,000

Gross salary: ₹20,12,800
Less exempt (HRA, conveyance, medical): ₹1,50,000
Less standard deduction: ₹75,000
Taxable salary: ₹17,87,800

Slabs:

Up to ₹4,00,000: ₹0
₹4,00,001 to ₹8,00,000: ₹20,000
₹8,00,001 to ₹12,00,000: ₹40,000
₹12,00,001 to ₹16,00,000: ₹60,000
₹16,00,001 to ₹17,87,800: 15% of ₹1,87,800 = ₹28,170

Tax before cess: ₹1,48,170
Cess (4%): ₹5,926.80
Final tax: ₹1,54,097

Common mistakes

Mistake 1 — treating HRA as fully exempt. HRA is only partly exempt. The exempt portion is the least of: the actual HRA received, 50% of basic salary (if you live in a metro) or 40% if non-metro, and the excess of actual rent paid over 10% of salary. If you do not pay rent, your entire HRA is taxable — even if your employer calls it an HRA allowance.

Mistake 2 — not disclosing perquisites from employer. If your employer gave you a car, paid your club fees, or gave you interest-free loans, these are taxable perquisites. Your employer should report them in Form 16. If they did not, you must declare them in your ITR. Failing to do so can lead to a notice under Section 148.

Mistake 3 — forgetting the standard deduction. Every salaried employee gets a standard deduction of ₹75,000 under Section 16(i). If you are computing your tax manually or using an older calculator, you may miss this and overstate your tax. The standard deduction is automatic — your employer applies it when computing TDS.

Mistake 4 — not checking Form 16 against your actual pay. Form 16 is built from your employer’s payroll records. Errors in allowances, perquisites, or deductions compound. Review it against your pay slips every year. If something looks wrong, ask your HR or payroll team to correct it before the financial year closes.

Frequently asked questions

Is pension taxable?

Pension is taxable as salary income under Section 15. If you receive a pension from a former employer (not under the EPF/Pension Act), it is treated as salary. If you receive a commuted pension (exchange of part of your regular pension for a lump sum), the exempt portion depends on whether you are covered by the Payment of Gratuity Act.

Are bonuses taxed?

Yes. All bonuses, whether performance-linked or fixed, are fully taxable as salary. They are added to your total income for the year and taxed at your marginal slab rate.

Is provident fund (PF) taxable?

Employee contribution to a recognized provident fund (EPF) is deductible under Section 80C (old regime) or reduces income under the new regime rebate. Employer contribution to EPF (above 12% of salary, if covered by the new wage code) may be taxable. Interest earned on EPF balances is tax-exempt if the employee is a regular EPF member.

What happens to salary income in the new regime?

Under the new regime, salary income is added to income from all other sources. The standard deduction of ₹75,000 is applied. There are no separate deductions for HRA, transport allowance, or medical allowance — these are all folded into the standard deduction. The tax is then calculated on the total using the slab rates.

Can I claim HRA if I am on the new regime?

The Income Tax Act 2025 does not provide a separate HRA exemption under the new regime. If you are on the new regime, you cannot claim the HRA exemption under Section 10(13A). However, the standard deduction of ₹75,000 is available. If you want to claim HRA, you must opt out of the new regime and use the old regime.

Disclosure: FinWiz24 is an independent editorial publication. We do not earn commission from any tax-related products or services discussed on this page.

Sources

Income Tax Act 2025, Section 15 — Income from salaries (verified 2026-10-08)
Income Tax Act 2025, Section 16 — Deductions from income from salaries (verified 2026-10-08)
Income Tax Act 2025, Section 17 — Definition of “salary” (verified 2026-10-08)
Income Tax Act 2025, Section 10(13A) — House Rent Allowance (verified 2026-10-08)
Income Tax Act 2025, Section 202 — Rate of tax under new regime (verified 2026-10-08)
CBDT Notification No. 22/2026 — Income-tax Rules 2026 (verified 2026-10-08)