Salary Income Under the Income-tax Act, 2025 — Complete Computation Guide

Last Updated: 15 April 2026  |  Applicable From: Tax Year 2026-27 (1 April 2026 onwards)  |  Reference: Income-tax Act, 2025 (30 of 2025), as amended by Finance Act, 2026

The Income-tax Act, 2025 is the first complete rewrite of India’s direct tax law in over six decades. It was passed by Parliament and received Presidential assent on 21 August 2025, and by the combined operation of Section 1(3) and the appointed notification it commences unconditionally on 1 April 2026. The first tax year under the new Act is therefore tax year 2026-27, running from 1 April 2026 to 31 March 2027. For roughly 8 crore salaried taxpayers in India, the practical question is simple: how is my salary now computed, and what changes from the 1961 Act regime that I grew up on? This guide answers that question section by section, with worked numerical examples, regime comparisons, and the precise cross-references you need when preparing ITR-1 or ITR-2 for tax year 2026-27 onwards.

Table of Contents

1. Charging scheme under the 2025 Act
2. Components of salary
3. Exempt and partially exempt allowances
4. Perquisites — valuation rules
5. Profits in lieu of salary
6. Standard deduction and Section 16 deductions
7. Retirement benefits — gratuity, leave encashment, pension
8. Provident fund, NPS and superannuation
9. ESOP taxation
10. Worked example — Rs 24 lakh salary
11. Old vs new regime — comparison table
12. Related articles in the series
13. Expert Insight
14. Key Takeaways
15. Frequently Asked Questions

1. Charging scheme under the 2025 Act

Chapter IV of the Income-tax Act, 2025 sets out the computation of total income under five heads, retaining the familiar classification — Salaries, Income from House Property, Profits and Gains of Business or Profession, Capital Gains, and Income from Other Sources. The “Salaries” head continues to be anchored by provisions equivalent to Sections 15, 16 and 17 of the repealed Income-tax Act, 1961. The structural difference is terminological: the dual concept of “previous year” and “assessment year” is replaced by a single concept of tax year, which runs from 1 April to 31 March. All Section 92 transitional rules of the 2025 Act confirm that references in the new Act to a tax year commencing on 1 April 2025 or earlier are to be construed as references to the corresponding previous year under the repealed 1961 Act.

Charging salary income on a due-or-receipt basis (whichever is earlier) continues. Advance salary is taxable in the tax year of receipt but is deductible in the tax year to which it relates if taxed again. Arrears of salary are taxable in the year of receipt if not already taxed, with relief under the Section 89 equivalent for salary pertaining to earlier tax years. Salary received by a partner from a firm is not taxable as salary — it is classified as business income under the PGBP head.

2. Components of salary

The definition of salary is inclusive and broad. Common components are:

• Basic pay, grade pay, dearness allowance (DA), dearness pay
• Bonus, commission (whether on turnover, profit or discretionary)
• Fixed and ad-hoc allowances (HRA, LTA, medical allowance, conveyance allowance, children education allowance, uniform allowance, etc.)
• Perquisites (company-provided accommodation, car, driver, loans below market rate, club membership, credit card, free utilities)
• Profits in lieu of salary (compensation on termination, keyman insurance, amounts from unrecognised provident fund)
• Gratuity, leave encashment, pension (subject to their own exemption framework)
• Employer contribution to recognised provident fund in excess of 12 per cent of salary, employer contribution to NPS in excess of 14 per cent, and employer contribution to approved superannuation fund in excess of Rs 1.5 lakh
• Contribution to an unrecognised provident fund, to the extent of employer contribution and interest accrued

3. Exempt and partially exempt allowances

Several allowances were traditionally exempt either fully or up to a prescribed ceiling. Under the Income-tax Act, 2025, most of these exemptions survive only under the old regime. The new regime (default) largely disregards these and taxes the gross allowance, compensating taxpayers through higher slabs and a larger standard deduction.

HRA worked example: Priya works in Mumbai, earns basic Rs 80,000 per month (Rs 9,60,000 per year) plus DA of Rs 8,000 per month forming part of retirement benefits, HRA of Rs 40,000 per month (Rs 4,80,000 per year), and pays rent of Rs 45,000 per month (Rs 5,40,000 per year). “Salary” for HRA = basic plus DA = Rs 9,60,000 + Rs 96,000 = Rs 10,56,000. Least of: (a) actual HRA Rs 4,80,000; (b) rent paid minus 10% salary = Rs 5,40,000 – Rs 1,05,600 = Rs 4,34,400; (c) 50% of salary (Mumbai is a metro) = Rs 5,28,000. Exempt HRA = Rs 4,34,400. Taxable HRA (old regime) = Rs 4,80,000 – Rs 4,34,400 = Rs 45,600. Under the new regime, the entire Rs 4,80,000 HRA is taxable.

4. Perquisites — valuation rules

Perquisites remain a critical component for senior employees. The 2025 Act retains the 1961 Act valuation structure through the prescribed rules, covering accommodation, motor cars, loans, movable assets, club facilities, free education and free meals. Key rules include:

Rent-free or concessional accommodation

For non-government employees in premises owned by the employer, the perquisite value is a percentage of salary depending on the city population: 10 per cent of salary in cities with population over 40 lakh, 7.5 per cent in cities with population between 15 and 40 lakh, and 5 per cent elsewhere (these slabs were rationalised from the earlier 15/10/7.5 structure and are retained under the 2025 Act). Furniture provided with accommodation adds 10 per cent per annum of the original cost of furniture. For rented accommodation taken by the employer, the perquisite is the lower of actual rent paid or the percentage computed as above.

Motor car

If a company car up to 1.6 litre capacity is used by an employee for both official and personal purposes and all expenses are borne by the employer, the monthly perquisite is Rs 1,800 (Rs 2,400 for cars above 1.6 litre). An additional Rs 900 per month is added if a driver is provided. If the car is exclusively for personal use, the perquisite is actual expenses plus 10 per cent of cost of car per annum plus driver cost.

Interest-free or concessional loans

The perquisite is the interest that would have been charged by the State Bank of India on 1 April of the tax year on the maximum outstanding monthly balance, less any interest recovered from the employee. Loans up to Rs 20,000 in aggregate and loans for medical treatment of specified diseases are exempt.

Movable assets and ESOPs

Free use of laptops and computers is not a taxable perquisite. Other movable assets are valued at 10 per cent per annum of original cost or actual hire charge. Gifts or vouchers up to Rs 5,000 in a tax year are exempt. ESOPs are dealt with separately (see Section 9 below).

5. Profits in lieu of salary

Profits in lieu of salary plugs the gap between “pure salary” and amounts received that still arise from the employer-employee relationship. Under the 2025 Act (Section 17(3) equivalent) this continues to include:

• Compensation received for termination or modification of terms of employment
• Payment from an unrecognised provident fund to the extent of employer contribution and interest thereon
• Payment under a keyman insurance policy, including bonus
• Any other sum received by the employee from the employer or former employer, whether before joining or after leaving employment, in connection with the employment

These amounts are fully taxable as salary, regardless of regime choice. Relief under the Section 89 equivalent (for amounts pertaining to earlier tax years) and exemption under the Section 10(10C) equivalent (voluntary retirement compensation up to Rs 5 lakh for eligible schemes) continue to be available.

6. Standard deduction and Section 16 deductions

Three deductions are available from gross salary:

1. Standard deduction: Rs 75,000 under the new regime (default) or Rs 50,000 under the old regime. This is a lump-sum deduction that requires no documentation.
2. Entertainment allowance: Only for government employees under the old regime — least of Rs 5,000, 20 per cent of basic salary, or actual entertainment allowance received.
3. Profession tax: Deductible in the year of actual payment, only under the old regime. No ceiling.

Salaried individuals without business income can switch regime each tax year simply by ticking the appropriate option in the return. Those with business or professional income must file Form 10-IEA to opt out of the new regime; once opted back into the default regime, they can opt out only once more.

7. Retirement benefits — gratuity, leave encashment, pension

Gratuity

For government employees, the entire death-cum-retirement gratuity is exempt. For employees covered by the Payment of Gratuity Act, 1972, exemption is the least of actual gratuity, Rs 20 lakh, or 15 days’ salary based on last drawn salary for each year of service (part of a year exceeding 6 months counted as a full year). For other employees, the 15 days is replaced with “half month’s average salary” computed over the 10 months preceding retirement. Gratuity received during service is taxable as salary in full.

Leave encashment

Government employees are fully exempt on retirement leave encashment. Other employees are exempt to the least of actual leave encashment, Rs 25 lakh (raised from Rs 3 lakh by a 2023 notification, retained under the 2025 Act), 10 months’ average salary, and the cash equivalent of leave (up to 30 days per year of actual service). Encashment during service is fully taxable.

Pension

Uncommuted pension is taxable as salary. Commuted pension is fully exempt for government employees; for others receiving gratuity, one-third of the commuted pension that would have been received had the full pension been commuted is exempt, and for others not receiving gratuity, one-half is exempt. Family pension received by legal heirs is taxable under “Income from Other Sources” with a deduction of Rs 25,000 or one-third, whichever is lower, under the new regime. See our Income from Other Sources guide for detailed family pension rules.

8. Provident fund, NPS and superannuation

Employer contribution to all three retirement funds — recognised provident fund (RPF), National Pension System (NPS) and superannuation fund — is a perquisite only to the extent it exceeds the aggregate of Rs 7.5 lakh per year (the ceiling continues from Budget 2020 amendments and is retained). Separately:

• RPF: Employer contribution up to 12 per cent of salary is exempt; in excess is taxable. Interest credited above 9.5 per cent per annum is taxable. Interest on employee contribution in excess of Rs 2.5 lakh in a year is taxable.
• NPS Tier-I: Employer contribution up to 14 per cent of salary is deductible in both regimes (government and private equally, after Budget 2024). Employee contribution up to Rs 1.5 lakh (within the overall Section 80C limit) and an additional Rs 50,000 under Section 80CCD(1B) is deductible only under the old regime.
• Superannuation fund: Employer contribution up to Rs 1.5 lakh per year is exempt; excess is taxable.

9. ESOP taxation

Employee Stock Option Plans are taxed twice: once as salary perquisite on exercise, and again as capital gains on eventual sale.

For employees of eligible start-ups, tax on the perquisite portion can be deferred to the earliest of (a) 48 months from the end of the tax year of exercise, (b) date of sale of the shares, or (c) date of leaving employment. This start-up ESOP deferral continues under the 2025 Act.

10. Worked example — Rs 24 lakh salary

11. Old vs new regime — comparison table

12. Related articles in the series

• Income from House Property under the Income-tax Act, 2025
• Profits and Gains of Business or Profession under the 2025 Act
• Capital Gains Tax under the 2025 Act — 12.5% LTCG explained
• Income from Other Sources under the 2025 Act
• Income-tax slabs and rebate for tax year 2026-27
• Old vs New regime decision guide under the 2025 Act

Expert Insight

Key Takeaways

• Income-tax Act, 2025 received assent on 21 August 2025 and commences 1 April 2026; first tax year is 2026-27.
• New regime standard deduction is Rs 75,000; old regime is Rs 50,000.
• Rebate of up to Rs 60,000 makes gross salary up to Rs 12.75 lakh tax-free in the new regime.
• HRA, LTA, 80C, 80D, 80CCD(1B) and home-loan interest remain in the old regime only.
• Employer NPS contribution up to 14 per cent of salary is deductible in both regimes.
• Gratuity exemption Rs 20 lakh and leave encashment Rs 25 lakh continue for non-government employees.
• Profession tax and entertainment allowance deductions are old-regime only.
• ESOP taxation continues on the two-stage model; start-up ESOP deferral is retained.
• Salaried without business income can switch regimes each tax year; with business income, only once.
• Maximum surcharge is capped at 25 per cent in the new regime (37 per cent in old regime).

Frequently Asked Questions

For a personalised salary tax review for tax year 2026-27, contact our team at virtualauditor.in/contact-us or call +91 99622 60333.