Many people don’t know much about how allowances are taxed. But before that, let us first start understand what an allowance is. An allowance is a fixed financial benefit given to the employee by an employer to meet certain expenditures over and above the employee’s salary. For example, your company may provide you with an overtime allowance. You may also get a conveyance allowance to foot the bill for any work-related commute.
Further, allowances are treated as part of the salary, and therefore, are taxable. However, the Income Tax Act has made some exceptions to this rule, and has categorized allowances into: Taxable, non taxable and partially taxable.
Dearness allowance (DA) is an allowance paid to an employee to cope with the rising inflation rate. Dearness allowance paid to the employee is fully taxable.
This type of allowance is paid to employees working in urban cities, where the cost of living may be higher. This allowance helps employees cope with higher living costs in cities.
If the employer provides marriage allowance, bereavement allowance or holiday allowance, it becomes fully taxable.
This is an allowance provided to an employee to meet all project-related expenses. This is also fully taxable.
As mentioned earlier, this is an allowance to compensate for the extra working hours. This again is 100% taxable.
This allowance is paid by an employer for the employee's accommodation.
Tax exemption under Section 10 (13A) can be claimed on whichever amount is lower:
Any amount of house rent allowance (HRA) received after claiming such deduction is taxable.
Expenses incurred by employees for traveling from home to office. This is generally limited to Rs 800 and is partially taxable.
Organizations that require their employees to report to work in a certain uniform pay a certain allowance. This again is partially taxable.
Transport expenses incurred for official purpose is also partly taxable.
Government servants are paid an allowance for serving in overseas offices. Such income is fully exempt from taxes.
These allowances, known as sumptuary allowances, are not taxable.
There are other allowances too. They vary from company to company. It is therefore important to understand your salary break-up. Once you have a clear picture of the tax treatment of your salary components, allowances don’t seem to be complicated any more.
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