How to Calculate Income Tax on Your Salary?

In simple terms, salary means the monetary benefit or remuneration that an employee receives from their employer in exchange for a service they offer over a certain period of time. The salary, paid at fixed or regular intervals, mostly on a monthly basis, comprises:

• Basic Salary – This is the set component of salary and can vary as per the terms and conditions of the employment contract.

• Fees/Commission/Bonus – These are the additional benefits that an employee can receive from their employer.

• Allowances – To help employees meet their personal expenses, certain allowances are also paid out, which can be partially or completely tax exempt.

Fully taxable allowances

• Dearness allowance, which is paid to the employees so that they can meet certain expenses during inflation to save tax in India.

• The city compensatory allowance is an amount or allowance paid out to employees who relocate to metro cities from other towns or cities and helps them meet the higher standards of living in the metro.

• An overtime allowance can be paid out to employees who work and render their services beyond the usual or regular office timings.

• Servant allowance and Deputation allowance.

Partly taxable allowances

The House Rent Allowance or HRA is completely taxable if the employee has their own home or their own place of residence. The exemption of the HRA is the least of the following:

• The house rent allowance (HRA)

• If an additional rent paid by the employee exceeds 10% of their salaried income.

• If the employee pays rent of 50% of their salary (metro) or 40% (other areas).

• Entertainment allowance, which does not apply to certain employees such as those of the State and Central Government.

• Certain allowances for travelling, buying uniforms for the job, research and others.

• An additional allowance that helps employees to manage expenses such as their children’s education, boarding school/hostel accommodation allowance and others.

Tax-exempt allowances

• Foreign allowance for employees working abroad for the company.

• Allowances paid to High Court and Supreme Court Judges.

• Allowances paid to United Nations Organisation employees.

Perquisites are payments that an employee receives over and above their salary. Additionally, no reimbursement is made for their expenses. These are some of the few perquisites that are taxed in the hands of the employees:

• Loans that are interest-free

• Rent-free accommodation

• Concession in residential rent

• Educational expenses

• Movable assets

• Payments for club fees

• Employee insurance premiums paid by the employer

• While some of the perquisites are taxable, they can be taxable for certain employees such as directors or key employees in an organisation who have extensive interest in the company. These perquisites are:

• Electricity, free cooking gas and resources meant for household purposes

• Concessional transport facility

• Concessional educational expenses

• Wages paid out to sweepers, gardeners, and helpers.

Apart from these perquisites, the others are exempt from taxes. These are some of the benefits on which no tax is levied:

• Healthcare benefits

• Medical insurance premiums

• Staff Welfare Scheme

• Concession for leave travel

• Vehicles or laptops for personal use.

• Retirement benefits are paid to employees during their service or after they retire.

• The pension of an employee that is paid a lump sum amount on retirement or as a monthly income. This can be taxable, depending on the employee’s category.

• Gratuity paid to an employee for their performance through their career during retirement time is exempt from tax up to a certain limit.

• The tax on leave salaries depends on the employee’s category or on how they want to use their leaves. Alternatively, they can also encash these leaves.

• EPF contributions made by the employee and employer every month. The interest received by the employee at the time of withdrawing or receiving the amount can be taxable if the interest exceeds ₹2.5 Lakh.

Life insurance plans from Tata AIA Life Insurance offer tax deductions and benefits as per the prevailing tax laws under Section 80C and 10(10D) of the Income Tax Act.

Before you calculate income tax on salary, gather the details required to determine your taxable income and applicable tax liability. Having these details ready can make the calculation simpler and more accurate.

Salary details

• Gross salary: Check your annual salary from your salary slips or Form 16.

• Basic salary: Note your basic pay, as it may be relevant for certain exemptions.

• Allowances: Include HRA, LTA and other allowances received during the financial year.

• Bonus and incentives: Add any bonuses, commissions or other taxable salary components. 

Exemptions and deductions

• Check your eligibility for applicable salary exemptions, such as HRA.

• Keep records of eligible deductions under the relevant provisions of the Income-tax Act, 2025.

• Include eligible NPS contributions, health insurance premiums and other qualifying deductions.

Other income

• Add income from interest, dividends, rental property, capital gains or other sources. 

• Keep relevant statements and documents to report these amounts accurately.

Tax regime

Choose between the old and new tax regimes, as the available exemptions and deductions differ between them. This is vital for how you calculate income tax on salary and estimating your final tax liability.

Calculating income from salary involves identifying your salary components, adding other taxable income where applicable, and arriving at the income on which tax is calculated. Follow these steps to understand the process clearly.

Step 1: Calculate your gross salary

Start by adding all taxable components received from employment during the financial year. These may include:

• Basic salary

• Dearness allowance

• House Rent Allowance (HRA)

• Leave Travel Allowance (LTA) 

• Bonus and incentives

• Commissions

• Taxable perquisites and other allowances

Your salary slips and Form 16 can help you identify the relevant amounts.

Formula: Gross salary = Basic salary + allowances + bonuses + taxable perquisites + other salary components

Step 2: Identify applicable salary exemptions

Next, identify exemptions that may be available against specific salary components. For example, eligible HRA may receive an exemption subject to the applicable conditions and limits.

The exempt portion is reduced from the relevant salary component to arrive at the taxable salary.

Formula: Taxable salary = Gross salary − eligible salary exemptions

Step 3: Apply the standard deduction

After accounting for applicable salary exemptions, deduct the standard deduction available under the tax regime chosen. For 2026-27, the standard deduction is ₹75,000 under the new tax regime, subject to the applicable provisions.

For example, if your taxable salary after eligible exemptions is ₹9,50,000:

₹9,50,000 − ₹75,000 = ₹8,75,000

This gives the income from salary after the standard deduction.

Step 4: Add income from other sources

If applicable, add taxable income from other heads, such as house property, business or profession, capital gains and other sources. This helps arrive at your gross total income.

For instance:

This step is important when understanding how to calculate income tax on salary, as your final tax liability may depend on your total taxable income rather than salary alone.

Step 5: Arrive at taxable income

Once income from all applicable sources has been determined, consider the deductions available under the selected tax regime. The resulting amount is your taxable income, which is then used to calculate your tax liability.

Formula: Taxable income = Gross total income − eligible deductions

The next stage is to apply the applicable income tax slab rates, consider eligible rebates and add the applicable cess to determine your total tax liability.

The 2025 Budget introduced revised income tax slabs under the new tax regime, applicable from FY 2025-26 (AY 2026-27). The revised structure increased the basic exemption limit to ₹4 lakh and increased the Section 87A rebate to ₹60,000 for eligible resident individuals with total income up to ₹12 lakh.

New tax regime

The new regime is the default tax regime for individuals. For eligible resident individuals, the Section 87A rebate can reduce the tax liability to nil where total income does not exceed ₹12 lakh, subject to the applicable conditions.

Old tax regime

For individuals below 60 years, the old tax regime continues with the following slabs:

The old regime allows various exemptions and deductions that are restricted under the new regime. Therefore, comparing both regimes is important when deciding how can we calculate income tax based on your income and eligible deductions.

How the slabs are used

Tax is calculated progressively across the applicable slabs rather than applying one rate to the entire income. For example, if your taxable income is ₹15 lakh under the new regime, the first ₹4 lakh is taxed at 0%, the next ₹4 lakh at 5%, the next ₹4 lakh at 10%, and the remaining ₹3 lakh at 15%.

This slab-based approach is an important part of understanding how I calculate income tax on salary. In simple terms, the how to calculate income tax formula involves determining taxable income, applying the relevant slab rates, adjusting eligible rebates and adding applicable cess.

Understanding how to calculate income tax on salary becomes easier when you follow a structured process. Start by identifying your salary components, applicable exemptions and deductions, then add income from other sources to determine your taxable income. Finally, apply the relevant tax slabs, rebates and cess to calculate your tax liability. Comparing the old and new tax regimes can also help you understand which provisions apply to your income and circumstances.