Salary Income Under Income-tax Act, 2025 : Complete Tax Guide for Employees

Salary is one of the most common heads of income for individual taxpayers. Although the Income-tax Act, 2025 has reorganised and renumbered many familiar provisions, the basic principle remains broadly similar: salary, allowances, taxable perquisites, bonus, commission, pension and certain employment-related receipts are taxed under the head “Salaries”.

Employees need to be particularly careful during 2026 because AY 2026-27 and Tax Year 2026-27 are governed by different Income-tax Acts.

Which Income-tax Act applies to your salary?

The Income-tax Act, 2025 applies from 1 April 2026. Income earned during FY 2025-26 remains governed by the Income-tax Act, 1961 even though the return is filed after the new Act has commenced.

This distinction is important. An employee filing the return for AY 2026-27 during 2026 is still filing under the Income-tax Act, 1961. The first return for a full year governed by the Income-tax Act, 2025 will relate to Tax Year 2026-27 and will generally be filed in 2027.

Salary provisions: Income-tax Act, 1961 vs Income-tax Act, 2025

When is salary taxable under Section 15?

Section 15 of the Income-tax Act, 2025 taxes salary in the following situations:

• Salary becomes due during the tax year, even if it has not yet been received.
• Salary is received in advance.
• Salary arrears are received, provided they were not taxed earlier.
• Salary is received from a former employer.

Salary already taxed when received in advance is not taxed again when it subsequently becomes due.

Remuneration received by a partner from a partnership firm is not treated as salary for Section 15 purposes.

What is included in salary under the Income-tax Act, 2025?

Section 16 gives salary a broad meaning and includes, among other items:

• Wages and basic salary
• Annuity or pension
• Gratuity
• Fees and commission
• Taxable allowances
• Perquisites
• Profits in lieu of salary
• Advance salary
• Leave encashment
• Specified taxable provident fund accretions
• Specified employer contributions to pension and retirement funds

Therefore, taxable salary is not limited to an employee's monthly basic pay.

Taxation of allowances

Allowances generally form part of salary unless a specific exemption is available. Their tax treatment may also differ depending on whether the employee chooses the new or old tax regime.

House Rent Allowance (HRA)

HRA exemption continues under the Income-tax Act, 2025 through Schedule III read with Rule 279 of the Income-tax Rules, 2026. However, HRA exemption is generally not available where income is computed under the new tax regime under Section 202.

Under the old regime, exempt HRA is the least of:

• Actual HRA received
• Rent paid minus 10% of salary
• 50% of salary where the employee resides in a specified city or
• 40% of salary for other locations

Under Rule 279 of the Income-tax Rules, 2026, the specified cities for the 50% salary test include Mumbai, Kolkata, Delhi, Chennai, Hyderabad, Pune, Ahmedabad and Bengaluru.

Example: HRA exemption in Bengaluru

Assume an employee has:

• Salary for HRA purposes: ₹9,00,000
• HRA received: ₹3,00,000
• Annual rent paid: ₹3,60,000

Therefore, ₹30,000 of the HRA would remain taxable, assuming all relevant conditions are satisfied.

Leave Travel Concession or LTA

Leave Travel Concession continues through Schedule III read with Rule 278. The exemption is restricted to eligible travel within India and is subject to prescribed fare limits and conditions.

Generally, exemption can be claimed for two journeys in a block of four calendar years, subject to the applicable rules. The exemption is generally not available under the new tax regime.

Perquisites received from an employer

Section 17 deals with taxable perquisites. Depending on the facts and applicable valuation rules, taxable perquisites may include:

• Rent-free or concessional accommodation
• Specified benefits or amenities
• ESOPs or sweat equity shares provided free or at a concessional price
• Amounts paid by the employer to discharge an employee's personal obligation
• Specified employer contributions to retirement funds

For ESOPs, the taxable perquisite value is generally linked to the fair market value of the specified security on the date of exercise, reduced by the amount paid or recovered from the employee, subject to prescribed rules.

Aggregate employer contributions exceeding ₹7,50,000 in a tax year to specified recognised provident fund, pension scheme and approved superannuation fund arrangements may also attract perquisite taxation, along with prescribed annual accretion relating to the excess contribution.

Profits in lieu of salary

Section 18 covers specified employment-related receipts that may not form part of ordinary monthly salary. These can include compensation received from an employer or former employer on termination of employment or modification of employment terms and certain payments received before joining or after leaving employment.

Standard deduction under Section 19

Employees do not need to prove any actual expenditure for claiming the standard deduction.

Professional tax

Section 19 permits deduction of eligible tax on employment, commonly known as professional tax, actually paid during the tax year. However, this deduction is generally not available where the employee is taxed under the new regime under Section 202.

Retirement-related receipts

Section 19 also contains provisions relating to certain salary and retirement-related deductions. Depending on the nature of employment and prescribed conditions, these may cover:

• Gratuity
• Commuted pension
• Retrenchment compensation
• Voluntary retirement compensation
• Leave encashment

The tax treatment and limits differ depending on the nature of the receipt and category of employee. Such receipts should therefore be examined separately rather than automatically treating the entire amount as taxable.

New tax regime under Section 202

The new tax regime is the default regime under the Income-tax Act, 2025. For Tax Year 2026-27, the slab rates are:

Health and Education Cess is charged at 4% of income-tax plus applicable surcharge.

Rebate up to ₹12 lakh under the new regime

Section 156 provides a rebate to an eligible resident individual whose total income under the new regime does not exceed ₹12 lakh. The rebate is restricted to the lower of the income-tax payable and ₹60,000.

Marginal relief is also available in specified cases where total income marginally exceeds ₹12 lakh.

Because a salaried employee under the new regime is eligible for a standard deduction of ₹75,000, an employee having only normal slab-rate salary income can generally have nil tax where gross salary does not exceed ₹12,75,000, subject to applicable rebate conditions.

This ₹12.75 lakh figure should not be treated as a universal tax-free income limit, particularly where the taxpayer also has income taxable at special rates.

Example: Salary of ₹12.50 lakh under the new regime

Example: Salary of ₹15 lakh under the new regime

What deductions are lost under the new regime?

Section 202 requires taxable income to be computed without several exemptions and deductions. For salaried employees, important restrictions generally include:

• HRA exemption
• LTA exemption
• Professional tax deduction
• Interest on borrowed capital for a self-occupied house property
• Most investment-linked deductions corresponding to the earlier Chapter VI-A framework

Certain specified deductions, such as eligible employer contributions to pension or NPS arrangements, continue subject to the applicable provisions.

New regime vs old regime for employees

There is no single tax regime that is always better for every employee. Employees with substantial HRA, home-loan benefits or eligible deductions should compare their tax liability under both regimes before filing.

Relief for salary arrears under Section 157

An employee receiving arrears or advance salary may face a higher tax burden because income relating to different years is concentrated in one tax year.

Section 157 provides relief in specified cases involving:

• Salary arrears
• Advance salary
• Salary relating to more than 12 months received in one tax year
• Specified profits in lieu of salary

This provision broadly succeeds the relief earlier available under Section 89 of the Income-tax Act, 1961.

TDS on salary under Section 392

Under Section 392, an employer is required to deduct income-tax at the time salary is paid. TDS is generally calculated using the average rate of income-tax applicable to the employee's estimated salary income for the relevant tax year.

Salary paid before 1 April 2026 was governed by the Income-tax Act, 1961 for TDS purposes. Salary paid on or after 1 April 2026 is governed by the Income-tax Act, 2025, subject to the applicable transition rules.

Form 16 has been replaced by Form No. 130 under the new Act

One of the important procedural changes for employees is the salary TDS certificate.

For salary relating to FY 2025-26, employers continue to issue Form 16 under the Income-tax Act, 1961.

For salary relating to Tax Year 2026-27, the salary TDS certificate under the Income-tax Rules, 2026 is Form No. 130.

Rule 215 requires Form No. 130 to be issued by 15 June of the financial year immediately following the tax year. Accordingly, for Tax Year 2026-27, the certificate would generally be due by 15 June 2027.

Common mistakes employees should avoid

Documents employees should keep

• Salary slips
• Form 16 or Form No. 130, as applicable
• Employer's perquisite statement
• Rent receipts and landlord details for HRA claims
• Travel evidence for LTA claims
• Proof of eligible investments and deductions
• Home-loan interest certificate, where relevant
• Previous-employer salary and TDS details
• Documents relating to salary arrears or retirement receipts

The Income-tax Rules, 2026 also prescribe Form No. 124 for employee claims relevant to salary TDS, broadly corresponding to the earlier Form 12BB framework. Form No. 123 broadly replaces the earlier Form 12BA dealing with specified perquisites and profits in lieu of salary.

Conclusion

The Income-tax Act, 2025 retains the basic framework for taxing employment income but reorganises the law into Sections 15 to 19 and renumbers several familiar provisions relating to the tax regime, rebate, salary arrears and TDS.

For employees, the key points for Tax Year 2026-27 include the ₹75,000 standard deduction under the new regime, rebate for eligible resident individuals with total income up to ₹12 lakh, restrictions on HRA, LTA and many deductions under the new regime, revised HRA rules and replacement of Form 16 by Form No. 130 for salary governed by the Income-tax Act, 2025.

Employees filing AY 2026-27, however, must continue to follow the Income-tax Act, 1961 because that return relates to income earned before the new Act became effective.

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