Every employer who is paying a ‘salary’ to their employees must deduct tax (tax deducted at source) on the month’s salary. However, unlike other incomes, TDS rate on salary income is not fixed. It is dependent upon the total estimated taxable income of the employee in the relevant financial year, among other factors.
“The employer deducts TDS on salary at the employee’s ‘average rate’ of income tax. This is because TDS on salary is not deducted at a flat rate,” says Abhishek Soni, co-founder, Tax2Win, a tax filing assistance platform.
Here’s how this TDS deduction works and how it can impact your monthly income.
Also read: Tax demand up to Rs 1 lakh/person waived: Check ITR a/c.
How is TDS on salary calculated?
The calculation of TDS is dependent upon the estimated net tax liability of the employee. In the process various factors such as tax regime chosen by the employee, tax exempted income, expenses and eligible deduction on tax savings investments (if any was made) are also considered. In order to make sure that a correct amount of TDS is being deducted, employers ask employees at the beginning of the financial year to declare their expenses and investment which would be eligible for tax deduction or exemption. Employers also ask employees to choose the tax regime (old/new) at the start of the financial year. Based on the declaration given by the employees, the employer deducts an average TDS each month typically until the last quarter of the financial year. And as the end of the financial year approaches employers ask for proof of tax savings investments which the employees declared earlier.According to Suresh Surana, founder, RSM India, a tax and business consulting group, “As per section 192 the amount of income-tax to be deducted shall be computed on the basis of the rates in force for the financial year in which the payment is made, based on the estimated income of the employee for the year.”Here’s a Table showing a detailed process for calculating TDS under both old and new tax regime:
Particulars | Old Tax Regime | New Tax Regime |
Basic Salary | xxxx | xxxx |
Add: Allowances (HRA,LTA, etc) | xxx | xxx |
Less: exemptions for allowances (HRA, LTA, etc) | (xx) | No exemption |
Gross Salary | xxxx | xxxx |
Less: Standard deduction | (xx) | (xx) |
Less: Professional tax paid | (xx) | No exemption |
Net Salary income chargeable to tax | xxxx | xxxx |
Income from other sources | – | |
Capital gains | – | – |
Income from house property | – | – |
Less: Deductions (as declared to employer) | (xx) | Only section 80CCD(2) deduction available |
Total taxable income | xxxx | xxxx |
Estimated tax liability for the year (A) | xxx | xxx |
TDS to be deducted under section 192 (A/12) | xxx/12 months= Rs xxx | xxx/12 months= Rs xxx |
Source: RSM India, a tax and business consulting group.
How is the rate of TDS determined?
The employer calculates their employees’ tax liability based on the ‘average rate of income tax’. The average rate of income tax means that once the net taxable income is estimated, the total tax liability would be estimated and deducted from the net salary income. The total tax amount would then be divided by 12 months and the figure thus derived would be deducted from each month’s salary as TDS.
Here’s a table explaining how the rate of TDS is determined in the old tax regime:
Particulars | Amount |
Estimated Total Income | Rs 7,60,000 |
Estimated Tax Liability | Rs 64,500 |
Add : Health & education cess @ 4% on Rs. 64,500 | Rs 2,580 |
Estimated Total Tax Liability (A) | Rs 67,080 |
TDS per month (A/12 months) | Rs 5,590 |
Salary per month | Rs 80,000 |
Less :- TDS per month (As calculated above) | Rs 5,590 |
Net salary in hand of the employee | Rs 74,410 |
Source: Tax2Win, a tax filing assistance company
In the example above the TDS amount was Rs 5,590 and the employee’s total tax liability was Rs 67,080 while the total income was Rs 7,60,000. So, the average rate of income tax under the old tax regime comes to Total tax liability/total income*100= 67,080/7,60,000*100= 8.8263%. Hence the employer would deduct 8.8263% from the monthly salary of the employee.
The average rate of tax as calculated above would remain the same throughout the year unless certain circumstances arise.
When can the TDS rate change?
Since the rate of deduction of TDS is based on the tax regime chosen and declarations made by the employee, it may undergo a revision if there is any change in certain circumstances.
According to Surana here are some circumstances which can cause the TDS rate to be revised:
- Actual tax saving investments made during the year by the employee might change as compared to declarations submitted at the beginning of the financial year,
- Any Increment / Bonus received by the employee which was otherwise not forming a part of total compensation,
- Revision in the salary structure of the employee such as change in the allowances, perquisites provided to the employee,
- Employee switching jobs in between the financial year.
“If an employee has income from multiple sources, such as salary, freelance work, rental income, etc., it may impact the TDS deductions. Employers need to account for all sources of income while calculating TDS hence employees need to declare all their income,” says Soni.
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