When you have employees, the majority of their income is taxable. That includes basic pay, overtime allowance, bonuses, and special allowances, but there are a few types of allowances that are not taxed. You don’t have to make any payments to the employee provident fund and your employees can claim an exemption on their tax returns so they don’t pay income tax on these amounts.
1. Transport Allowance
If you provide free rides to work, your employees can’t claim an exemption for the transport or conveyance allowance, but if you provide them with an allowance to cover their travel costs to and from work prior to finance act 2018, they could claim an exemption. The exemption was worth ₹1,600 per month or up to ₹19,200 per year. Blind, deaf, or handicapped employees could claim twice that amount. Any travel allowance over this threshold was also taxable. Also, a transport business employee was given transport allowance for meeting personal expenditure during running of such transport. This allowance amounted to the lower of 70% of such allowance or Rs. 10,000 per month.
Changes in Finance Act 2018
However, Finance Act, 2018 made changes to this. It introduced standard deduction of Rs 40,000 in exchange of transport allowance of Rs 1600 per month and medical allowance of Rs 15,000. This change came into effect from financial year 2018-19. Accordingly, no separate transport allowance of Rs 1,600 per month is available to employees other than physically challenged employees and employees of transport business.
2. Medical Reimbursement
This benefit is no longer available with effect from financial year 2018 – 2019. Medial insurance premiums you paid for employees prior to this were not taxable. If you reimbursed your employees for any of their personal or family medical expenses, those amounts were also not taxable. Generally, the limit for these combined expenses was ₹15,000, but as of fiscal year 2018 to 2019, your employees can claim a deduction of up to ₹40,000 for their medical reimbursements, medical premiums, and transportation allowance combined. In contrast, if you decide to give your employees a medical allowance, that amount is fully taxable, but you don’t have to worry about getting receipts or copies of medical bills.
3. Leave Travel Allowance
Your employees can claim an exemption if you give them an allowance for leave travel. The employee’s spouse, children, or parents can accompany them, but the allowance can’t cover travel costs for the employee’s friends or distant relatives. To claim the exemption, your employees must give you receipts for their travel costs, and they can only claim this exemption twice every four years.
Their claim must be less than the amount received from you or the cost of reaching their destination. For instance, if you give your employees a ₹4,000 allowance to fly from Mumbai to New Delhi, but the cheapest airline tickets are only ₹3,500, your employees can claim a tax-free exemption of ₹3,500. They must pay tax on the remaining ₹500 of the allowance received from you. When calculating the threshold for this exemption, use the cost of taking a first class air conditioned railway or an economy class national airline carrier.
4. House Rent Allowance
To help your employees cover rent, you may want to provide house rent allowance. As long as they use the money to pay rent, it is also tax exempt. They can claim the deduction which is the least of following amounts:
- actual house rent allowance received from the employer
- 50% of their basic salary + dearness allowance if they live in a metro area, or up to 40% of basic + dearness allowance in other areas.
- actual rent paid less 10% of basic salary + dearness allowance.
5. Children Education Allowance
If you provide an education allowance for your employee’s children, they also don’t have to pay tax on that amount. The exemption is worth up to ₹100 per month or ₹1200 per year, per child, up to two children.
Figuring out what’s taxable can be tricky, but software can help. When you invest in cloud-based accounting software such as QuickBooks, you can add payroll tools, which are constantly updated to reflect changes to the rules.