How is TDS calculated on a salary?
Tax deducted at source (TDS)
In India, under the Indian Income Tax Act of 1961, TDS is a method of collecting income tax. TDS is the amount that is deducted by the employer at the time of payment to the employee & later deposited to the government. The tax is deducted at the source from where the income is generated.
TDS is applied to a variety of financial transactions, including salary, commission, brokerage, contract payments, interest from various financial investments, winnings from lotteries, rent income, professional fees, etc. TDS is managed by the Indian Revenue Service’s Department of Revenue, which is a division of the Central Board for Direct Taxes (CBDT).
How is TDS calculated on a salary?
The employer calculates TDS by estimating the net taxable salary and subtracting TDS from it. The net salary income is determined by subtracting the tax-free allowances and exemptions from the gross salary. Then, if you submit tax-saving investments and expenses, they will be subtracted from the income from salary. If you declare it, any other income will be added to your salary. The TDS is then subtracted, based on the category into which your net taxable income falls.
The following steps are taken in the TDS deduction
- Total earnings calculation – The employer determine the employee’s total earnings.
- Calculating the total amount eligible for the exemption – It is the employer’s responsibility to determine the total amount eligible for tax exemption.
- Employee’s declaration and investment proof – The employer must get the employee’s investment and proof of investment.
- Depositing TDS deductions – TDS deductions must be deposited with the central government, and the employer is responsible for doing so.
The following allowances are exempt from taxes:
- House Rent Allowance
If an employee is paying rent for housing, he or she may be eligible to receive a house rent allowance (HRA) from the company.
- Standard Deduction
The Government has offered a flat deduction of Rs 50,000 instead of transportation and medical benefits.
- Children Education Allowance
A monthly Allowance is allowed of Rs.100 per child for upto 2 children.
- Leave Travel Allowance
Employees can travel while at work, pay their travel costs, and then seek reimbursement from their employer via LTA. For this reason, your compensation should include LTA. Additionally, the LTA that the employee received is not included in the employee’s net taxable income according to Section 10(5) of the Income Tax Act of 1961. Leave Travel allowance can only be claimed on their actual trip expense or the component amount of your pay breakdown, whichever is less. However, employees are only allowed to use LTA for 2 trips in a block of 4 years.
For example:
Basic salary – INR 7 lakhs
Dearness allowance – INR 2 lakhs
HRA – INR 1 lakh
LTA – INR 1 lakh
Bonus – INR 2 lakhs
Gross salary – INR 13 lakhs (The total of the abovementioned amounts would be the gross salary)
The net salary would be calculated using the following formula:
| Gross salary | INR 13 lakhs | |
| Less: Tax-exempted HRA | INR 1 lakh | |
| Less: Tax-exempted LTA | INR 1 lakhs | |
| Less: Standard deduction | INR 50,000 | |
| Net salary | INR 10,50,000 | |
| Less: Section 80C deductions declared by the employee | INR 1,50,000 | |
| Less: Section 80D deductions declared by the employee | INR 50,000 | |
| Net taxable salary | INR 8,50,000 | |
| Tax payable | Up to INR 5 lakhs – 5% of 2.5 lakhs = INR 12,500 INR 5 lakhs to INR 8.5 lakhs – 12,500 + 20% of 3.5 lakhs = INR 82,500 | |
| TDS deduction rate | Tax liability / gross total income * 100 = 82500 / 13 lakhs * 100 = 6.35% |
Therefore, the company would deduct tax at a rate of 6.35% from the salary income and then credit the employee’s salary.
