Understanding Section 16(2) of the Income Tax Act: Taxation of Salary Income

Section 16(2) of the Income Tax Act, 1961, lays down the provisions related to the salary income of an individual. Salary income is the remuneration received by an employee from an employer in consideration of services rendered by the employee. The section enumerates the various components of salary income that are taxable in the hands of the employee. In this blog, we will discuss the various aspects of Section 16(2) of the Income Tax Act.

Components of Salary Income

The following components of salary income are taxable under Section 16(2):

1. Basic Salary: This is the fixed amount paid by the employer to the employee as per the terms of employment.
2. Dearness Allowance (DA): DA is an allowance paid to the employee to compensate for the rise in the cost of living. It is linked to the Consumer Price Index and is revised periodically.
3. House Rent Allowance (HRA): HRA is an allowance paid by the employer to the employee to meet the expenses incurred on rented accommodation.
4. Conveyance Allowance: This allowance is paid to the employee to meet the expenses incurred on commuting to and from the workplace.
5. Medical Allowance: This is an allowance paid by the employer to the employee to meet the medical expenses incurred by the employee or his/her family members.
6. Leave Travel Allowance (LTA): LTA is an allowance paid to the employee to meet the expenses incurred on travel during the leave period.
7. Bonus: This is a variable component of salary paid by the employer to the employee as a reward for good performance.
8. Commission: This is a variable component of salary paid by the employer to the employee as a percentage of sales made by the employee.

Exemptions under Section 16(2)

The following exemptions are available under Section 16(2):

1. Transport Allowance: A maximum exemption of Rs. 1,600 per month can be claimed by the employee for transport allowance received from the employer.
2. Medical Reimbursement: The reimbursement of medical expenses incurred by the employee or his/her family members up to Rs. 15,000 per year is exempt from tax.
3. Leave Travel Allowance (LTA): LTA received by the employee twice in a block of four years is exempt from tax. The current block is from 2018-2021.
4. HRA: HRA received by the employee is exempt from tax to the extent of the least of the following: (i) Actual HRA received, (ii) Rent paid minus 10% of basic salary, (iii) 50% of basic salary if the employee resides in metro cities (Delhi, Mumbai, Chennai, Kolkata) or 40% of basic salary if the employee resides in non-metro cities.

In addition to the components of salary income and exemptions discussed in the previous section, there are a few other aspects to be aware of:

1. Perquisites: In addition to salary income, an employee may also receive perquisites from the employer, such as a company car, club membership, or free accommodation. These perquisites are taxable in the hands of the employee, and their value is determined as per the rules laid down by the Income Tax Act.
2. Deductions: Certain deductions are allowed from the gross salary income to arrive at the taxable income. These deductions include contributions to provident fund, pension fund, and insurance premiums. However, the maximum deduction allowed for these contributions is limited to a certain percentage of the basic salary.
3. Tax Deducted at Source (TDS): Employers are required to deduct TDS from the salary and allowances paid to the employee, based on the applicable tax rates. The TDS deducted is then deposited with the government and the employee can claim credit for the same while filing their income tax return.
4. Salary Arrears: If an employee receives salary arrears in a financial year, the tax on such arrears is calculated separately and added to the tax payable for that year. However, if the employee receives relief under Section 89, the tax liability can be reduced.

It is important to note that the provisions of Section 16(2) apply only to individuals who are employees and receive salary income. Other categories of taxpayers, such as self-employed individuals and freelancers, are subject to different rules for taxation of their income.

In conclusion

Section 16(2) of the Income Tax Act is a crucial provision that lays down the rules for taxation of salary income of employees. Understanding the various components of salary income, exemptions, deductions, and other aspects can help individuals and employers comply with the provisions of the Act and avoid any penalties or legal issues.

Read more useful content:

• section 234e of income tax act
• section 286 of income tax act
• section 90a of income tax act
• section 40a(7) of income tax act
• section 226(3) of income tax act
• section 24 of income tax act

Frequently Asked Questions (FAQs)

Q: What is Section 16(2) of the Income Tax Act?

A: Section 16(2) of the Income Tax Act lays down the provisions related to the salary income of an individual. It enumerates the various components of salary income that are taxable in the hands of the employee.

Q: What are the components of salary income that are taxable under Section 16(2)?

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A: The components of salary income that are taxable under Section 16(2) include basic salary, dearness allowance (DA), house rent allowance (HRA), conveyance allowance, medical allowance, leave travel allowance (LTA), bonus, and commission.

Q: What are the exemptions available under Section 16(2)?

A: The exemptions available under Section 16(2) include transport allowance, medical reimbursement, LTA, and HRA.

Q: What is the maximum exemption for transport allowance?

A: A maximum exemption of Rs. 1,600 per month can be claimed by the employee for transport allowance received from the employer.

Q: What is the maximum exemption for medical reimbursement?

A: The reimbursement of medical expenses incurred by the employee or his/her family members up to Rs. 15,000 per year is exempt from tax.

Q: What is the current block for LTA?

A: LTA received by the employee twice in a block of four years is exempt from tax. The current block is from 2018-2021.

Q: What is the maximum exemption for HRA?

A: HRA received by the employee is exempt from tax to the extent of the least of the following: (i) actual HRA received, (ii) rent paid minus 10% of basic salary, (iii) 50% of basic salary if the employee resides in metro cities or 40% of basic salary if the employee resides in non-metro cities.

Q: What are perquisites?

A: Perquisites are additional benefits or facilities provided by the employer to the employee, such as a company car, club membership, or free accommodation. These perquisites are taxable in the hands of the employee.

Q: What is TDS?

A: TDS stands for Tax Deducted at Source. Employers are required to deduct TDS from the salary and allowances paid to the employee, based on the applicable tax rates.

Q: What is the relief under Section 89?

A: If an employee receives salary arrears in a financial year, the tax on such arrears is calculated separately and added to the tax payable for that year. However, if the employee receives relief under Section 89, the tax liability can be reduced.

These are some of the common questions related to Section 16(2) of the Income Tax Act. It is advisable to consult a tax professional for any specific queries or clarifications related to the Act.