What is allowance in income tax and its types?

  • Updated on: 3 Jan 2024
  • Published on: 3 Jun 2016
What is allowance in income tax and its types?

Table of contents:

  1. House Rent Allowance (HRA)
  2. Education allowance for children
  3. Helper allowance
  4. Transport allowance
  5. Leave Travel Allowance (LTA)
  6. FAQs

As a taxpayer, you may be wondering what an allowance is in income tax. The answer is simple. An allowance is a part of a salaried individual’s basic salary. The employer pays the allowance at regular intervals. While generally, allowances are taxable, there are some tax-free allowances under Income Tax Act rules. 

Tax-free allowances in salary are those allowances that are usually paid to an employee for their service or as compensation to manage specific expenses. With the Indian Government offering different types of allowances, handling various costs is easier. 

While salaried professionals form a major part of India’s taxpayers, deductions can help you save by reducing your tax liability. As such, when you claim a tax-free allowance, your tax liability decreases. 

You can divide salary allowances into 3 categories:

  • Taxable
  • Non-Taxable
  • Partly Taxable

To get a brief overview of the different types of tax-free allowances in income tax, read on.

House Rent Allowance (HRA)

Among the various types of allowances in income tax, this is a popular one paid to an employee. As per Section 10(13A) & Rule 2A of the Income Tax Act, HRA is the amount an employer pays to compensate for the rent paid by an employee. To make this a tax-free allowance, you have to reside in rented accommodation; else, it becomes taxable. 

The tax deduction for this allowance depends on the following factors:

  • The rent you pay
  • Your salary
  • HRA provided
  • Place of employment
  • Your residence location

HRA is 50% of your basic salary along with a dearness allowance when residing in a metro city. However, if staying in a non-metro city, you may get 40% HRA, including the dearness allowance. The exempted amount would be the lowest of the 3 – actual HRA received, 40%/50% of the salary if rent paid less is 10% of the salary.

Education allowance for children

As you familiarise yourself with what is allowance in income tax, you should note that an amount spent on your child’s education is actually tax-free. As per the income tax provisions, you can get an exemption of up to ₹200 per month for up to 2 kids (₹100 each, ₹2,400 yearly). 

In case both your kids are studying in a boarding school, you can avail of an additional exemption of up to ₹600 per month for 2 children (₹300 each, ₹7,200 yearly). However, note that you can claim these allowances only for a maximum of 2 children.

Helper allowance

Amongst the various types of allowances, hiring an assistant to help complete your professional services can also exempt you from paying taxes. For instance, say you have hired a helper to complete your scheduled work. 

As per Section 10 (14), you can get a tax-free allowance to the extent of the amount. This helps you manage the expenses incurred by the assistant helping you with your official duties.

Transport allowance

This is another allowance paid to an employee to manage transportation costs when traveling to the workplace from home. According to Section 10(14), this allowance helps you meet the expenses you incur on your daily commute. 

Currently, the income tax division has combined transport with medical allowance by implementing a standard deduction value. While this standard deduction was ₹40,000 initially, the amount has been revised to up to ₹50,000.

Leave Travel Allowance (LTA)

As a salaried employee, you can avail of an LTA exemption according to the Income Tax Act. Simply put, LTA includes the travel expenses incurred during your leave duration. However, this does not include food, entertainment and shopping expenses. 

You are eligible to claim LTA twice in a gap of 4 years. In case you do not claim it within a block of 4 years, you can carry it forward to the next block. However, you can claim LTA only for domestic travel and not for international travel expenses. 

Here, the mode of travel has to be either public transport, train or plane to claim the LTA.

Now that you know more about allowances in income tax and have an idea about a few tax-free allowances, you can plan your taxes better and save more. As a salaried professional, you may also require funds to tackle unexpected emergencies. 

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FAQs about income tax allowances

Which allowances are tax-free?

Here are a few tax-free allowances:

  • Compensatory allowance
  • Children’s education allowance
  • HRA
  • Transport allowance
  • Helper allowance

What are tax-free allowances in salary?

Tax-free allowance means the allowance on which you can claim tax benefits or get a tax exemption.

What are the 3 types of allowances?

  • Taxable allowance
  • Partially taxable allowance
  • Tax-free allowance

How do I calculate my salary allowance?

While this differs based on your employer’s policies and salary structure, you can calculate your salary allowances by deducting your basic salary and PF contribution from your total package. Another way to look at it is by deducting your gross pay from your basic salary. 

How do tax-free benefits work?

Tax-free benefits help you avail tax exemptions on special allowances, thereby helping you save tax.

What are non-taxable allowances?

Non-taxable allowances are entirely exempt from taxation and they are also known as tax-free allowances. An example of this includes compensatory allowance, helper allowance, daily allowance, uniform allowance, and many more.

What are the different types of allowances?

A few types of allowances offered to taxpayers are: 

  • Leave travel allowance (LTA) 
  • House rent allowance (HRA) 
  • Conveyance allowance 
  • Medical allowance 
  • Cash allowance 

These allowances are further categorised into taxable, partially taxable and tax-free allowances.

Is allowance an income?

Yes, you need to add allowances under the Income From Salaries as per the Income Tax Act rules. 

Which allowance is fully taxable in salary?

The below allowances are taxable completely:

  • Dearness allowance
  • Overtime allowance
  • Cash allowance
  • Holiday allowance
  • Telephone allowance

What are examples of allowances?

Given below are a few examples of allowances in salary that an individual may receive:

  • Dearness allowance
  • House rent allowance (HRA)
  • Leave travel allowance (LTA)
  • Children education allowance
  • Entertainment allowance

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