What is an allowance? What are the types of allowance?

Taxpayers are usually aware of deductions under Section 80C of the Income Tax Act or for which they are eligible. However, it is noticed that taxpayers are unaware of the taxability of allowances and the exemptions available under different sources of income.

If you think that your entire salary is liable to taxes, then that is not true. Your overall package, often known as CTC, comprises many allowances. 

While your basic salary is fully taxable, there are other benefits offered to the employees in the form of allowances and prerequisites. These allowances are offered to employees for the expenses they bear during work. There are three types of allowances:

  • Fully-taxable allowances

The fully taxable allowances are not exempted from Income Tax. You have to pay the full tax applicable to these allowances.

  • Potentially taxable allowances

The partially taxable allowances are exempted from the Income Tax to a limit.

  • Fully Exempt allowances

The non-taxable allowances are exempted from the Income Tax fully. But, these are usually offered to government employees.

Let’s see how these allowances can impact your take-home salary.

Fully-taxable allowancesPotentially taxable allowancesFully Exempt allowances
Basic SalaryHouse Rent AllowanceFood Allowance
Dearness AllowanceLeave Travel AllowanceChildren education allowance
Special AllowanceCar Maintenance AllowanceConveyance Allowance
Overtime AllowanceDaily Allowance
BonusAcademic and Research Allowance


Wealth cafe Advice

As soon a person joins an organization, s/he is provided with the breakup of the fixed salary and allowances. However, most of the time individuals are ignorant about taxation. But allowances can help employees save taxes provided they are placed in the salary intelligently.

Salary restructuring is not possible in every organization, but if possible, employees should try to include allowances that are non-taxable or are partially taxable in nature. This way they can reduce the tax liability to some extent.

Thus, one should take note that through intelligent planning one can use allowances to save taxes and reduce the tax outflow.

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