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Income from Salary: Understanding Taxation for AY 2025-26

April 2, 2025
SAKUNTHALA GIRISH & ASSOCIATES LLP

Mr. A earned salary income, but his pay slip includes various components such as Basic Pay, Dearness Allowance, House Rent Allowance (HRA), Bonus, and PF deductions. But he is confused about whether the mentioned additions and deductions are covered under income tax. Check out the article fully to know about the implications.

How to Approach:

  • Part - 1 – Why is it needed?
  • Part - 2 – Components of Payslip & their impact
  • Part - 3 – Key Takeaways
  • Part - 4 – ITR's & Due Date

PART 1 – WHY IS UNDERSTANDING SALARY TAXATION IMPORTANT?

Every individual whose income earned during the year is more than INR 3,00,000/- is required to furnish an Income Tax Return (ITR) even if there is no outflow of income tax payment to the government. Understanding how your salary components are taxed is crucial for proper tax planning and compliance.

Benefits of Filing Income Tax Returns

  • Acts as an absolute income proof document for loans, insurance, VISA processing, and government registrations
  • Required by banks and financial institutions for high-value transactions (₹10 lakh+ in savings accounts, ₹50 lakh+ in property purchases)
  • Helps in getting refunds of excess tax paid on investments and salary

PART 2 – COMPONENTS OF YOUR PAYSLIP AND THEIR TAX IMPACT

Each organization compensates its employees through various pay structures beyond just Basic Salary and Dearness Allowance, such as Performance Bonus and Perquisites received through cash or assets. Understanding the tax implications of each component is essential for accurate tax calculation.

ComponentTaxability
Basic SalaryFully Taxable
Dearness AllowanceFully Taxable
House Rent AllowancePartially Exempt (subject to conditions)
Performance Bonus or Variable PayFully Taxable
Provident Fund
  • Employer's Contribution - Exempt
  • Interest Income from PF - Exempt
  • Employee's Contribution – Deduction u/s 80C
PerquisitesCan be taxable or non-taxable depending on type (e.g., rent-free accommodation, transportation facilities provided by the company)
Professional TaxDeduction available
Leave Travel Allowance (LTA)
  • Exempt if expenses are incurred
  • Can be claimed for a continuous period of 2 years out of a block of 4 years

HOUSE RENT ALLOWANCE (HRA) EXEMPTION

HRA exemption shall be the lowest of:

  • Actual HRA received
  • 50% of [basic salary + DA] for those living in metro cities (Delhi, Kolkata, Mumbai or Chennai)
  • 40% of [basic salary + DA] for those living in non-metros
  • Actual rent paid (-) 10% of [basic salary + DA]

PART 3 – KEY TAKEAWAYS FOR AY 2025-26

Standard Deduction

The standard deduction available for salaried individuals for the FY 2024-25 (AY 2025-26):

  • Old Tax Regime: Rs. 50,000
  • New Tax Regime: Rs. 75,000

Common HRA Claim Issues

  • Non-deduction of TDS for rent > ₹50,000/month
  • Mismatch in reported income and claims
  • Fake rent receipts & bogus claims
  • Large HRA claims without justification
  • Missing PAN of landlord (for rent > ₹1,00,000 per year)
  • Paying rent to family members without proof
  • Cash transactions without proper documentation
  • Claiming both HRA & home loan benefits

SALARY ARREARS AND TAX RELIEF

Under Section 89(1) of the Income Tax Act, tax relief is provided when a taxpayer receives certain types of income in arrears or in advance. This prevents higher tax liability due to income being taxed in a single financial year instead of being spread over multiple years.

Eligible Cases for Section 89(1) Relief

  • Salary received in arrears
  • Salary received in advance
  • Gratuity for past services
  • Pension in arrears or advance
  • Compensation for termination
  • Commuted pension
  • Leave encashment
  • Other payments for past services

Relief Calculation under Section 89(1):

  1. Determine tax payable on total income including arrears in the year of receipt
  2. Determine tax payable on total income excluding arrears in the year of receipt
  3. Find the difference between these two tax amounts (extra tax due to arrears)
  4. Calculate tax for each past year on total income including arrears
  5. Calculate tax for each past year on total income excluding arrears
  6. Find the difference for each year and sum them up
  7. Relief is the excess tax paid in the year of receipt compared to what would have been paid in correct years

Example:

Suppose Mr. A receives ₹3,00,000 as arrears of salary for the past three years in the financial year 2024-25. If adding this amount in 2024-25 moves him to a higher tax bracket, he can claim relief under Section 89(1) to reduce the additional burden by distributing the arrears over the respective years.

Form 10E must be filed online through the Income Tax e-filing portal before filing ITR to claim this relief.

PART 4 – SELECTING THE RIGHT ITR FORM

Selecting the appropriate Income Tax Return (ITR) form is essential to ensure compliance with tax laws and avoid potential discrepancies, penalties, or notices from the Income Tax Department. Filing the wrong ITR form can lead to rejection of the return, requiring rectification and resubmission.

When Should a Salaried Individual File ITR-2 Instead of ITR-1?

  • High-Income Earners: Total income exceeds ₹50 lakh
  • Capital Gains or Losses: If earned from sale of stocks, mutual funds, property, or other capital assets
  • Multiple House Properties: ITR-1 allows reporting of only one self-occupied property
  • Foreign Assets or Income: Foreign bank accounts, investments, property, or income from abroad
  • Agricultural Income: Exceeding ₹5,000
  • Company Director or Shareholder: Director in a company or holds unlisted shares
  • Residential Status: Non-resident or Resident but Not Ordinarily Resident (RNOR)

IMPORTANT DATES TO REMEMBER

Due Date to furnish ITR:

31st July 2025

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