You may have come across the term ‘Basic Salary’ on your payslip if you are a salaried employee. It is an employee’s base salary before any deductions or bonuses. Deductions and bonus amounts have a substantial impact on a person’s pay. Deductions are made for contributions to provident funds and tax payments, while bonus amounts are added based on the individual’s performance and the benefits he receives.
What is Basic Salary?
The Basic Salary is the sum agreed upon by both parties prior to the start of the job. Since it is determined before the job, it does not include any deductions or bonus amounts and is not the same as “take-home pay”. As the name implies, it is the foundation of the wage structure with major components like EPF, ESIC, and Gratuity depending on it.
The Basic Salary is determined by the applicant’s abilities, the position for which he or she is applying, and mutual agreement between the parties. It normally accounts for 40 to 45% of the company’s CTC. The Basic Salary is not susceptible to change. However, in gratitude for his service over the years, a corporation may grant an annual raise to an employee’s base pay. A rise in basic pay is generally accompanied by promotion at work.
Factors to consider while determining Basic Salary
Once you know what is basic pay, let us talk about the factors that determine the same. As an employer, there are 2 factors you need to consider while determining Basic Salary.
- High basic pay means you have to pay more as contributions to ESIC and EPF. High basic pay also makes employees have a high tax liability as Basic Salary is fully taxable.
- Low basic pay means you won’t have to pay as much in ESIC and EPF contributions, but you’ll run the risk of falling below the state government’s minimum wage requirements.
As a result, you must maintain an advantageous mediocre basic pay structure in which you offer a high and low basic salary to employees depending on their working position and personal skills.
How to calculate Basic Salary?
As previously stated, the Basic Salary is the foundation of the salary structure and is used to calculate the values of the other components. It is, nevertheless, very simple to determine a basic salary from other components such as Gross Salary or Net Salary.
- Basic Salary from Gross Salary
Gross Salary is the overall amount earned by an employee throughout a pay period, as the name suggests. It consists of the personnel’s basic salary as well as their benefits. The formula stands,
Gross Salary = Basic Salary + Allowances
So, to compute Basic Salary from Gross Salary, we’ll use the formula:
Basic Salary = Gross Salary – Allowances
An employee has a Gross Salary of 80,000 INR. He receives a House Rent Allowance of 30,000 INR, Dearness Allowance of 10,000 INR and Conveyance Fees of 5,000 INR.
Here, his Basic Salary will be:
Basic Salary = 80,000 – (30,000+10,000+5,000) INR
= 80,000 – 45,000 INR
= 35,000 INR
- Basic Salary from Net Salary
Net Salary or Take-home pay is the amount an employee receives after deducting tax and contribution to provident fund and adding allowance and bonus amounts to the basic pay. The formula stands,
Net Salary = Basic Salary + Allowances – Deductions from Tax and EPF
So, to compute Basic Salary from Net Salary, we’ll use the formula:
Basic Salary = Net Salary + Deductions from Tax and EPF – Allowances
An employee receives a take-home pay of 40,000 INR. It includes an HRA of 18,000 INR and Conveyance Fees of 3,000 INR. He pays 5% in tax and contributes 3% to EPF.
Here, his Basic Salary will be,
Basic Salary = 40,000 + 8% of 40,000 – (18,000+3,000) INR
= 40,000 + 3,200 – 21,000 INR
= 22,200 INR
Tax Liability of Basic Salary
As a salaried worker, you are well aware that you must pay a specific amount of tax based on your earnings. This is referred to as income tax. The Income Tax Act of 1961 contains the provisions that govern the Income Tax.
Every person pays income tax based on the amount of money they earn, which implies that those with higher incomes pay more tax than those with lower incomes. The amount you must pay as an employee is determined by the income tax bracket in effect at that financial year. It is subject to change every year. The state government uses the levy to fund social initiatives and services.
The Income Tax slab for the Financial Year 2021-22 is as follows:
Amount received as Income
Below 2,50,000 INR
2,50,000 to 5,00,000 INR
5,00,000 to 7,50,000 INR
12,500 INR + 10% of income exceeding 5,00,000 INR
7,50,000 to 10,00,000 INR
37,500 INR + 15% of income exceeding 7,50,000 INR
10,00,000 to 12,50,000 INR
75,000 INR + 20% of income exceeding 10,00,000 INR
12,50,000 to 1,500,000 INR
1,25,000 INR + 25% of income exceeding 12,50,000 INR
Above 15,00,000 INR
1,87,500 INR + 30% of income exceeding 15,00,000 INR
Difference between Gross Salary and Basic Salary
As mentioned earlier, Gross Salary and Basic Salary are two different components of the salary structure. Gross Salary is the aggregate amount earned by an employee during his or her pay period. The amount includes the basic pay, allowances, perquisites enjoyed by the personnel, and bonus amounts if received. It does not include any deductions from tax or fund contributions.
The basic salary, on the other hand, is the sum agreed upon by both parties prior to the start of the job. It is the most important part of the salary structure since it determines allowances, tax and fund contributions, and gratuity. The whole sum decided as basic pay is taxable and a part of the employee’s take-home pay.
The formula to determine Basic Salary from Gross Salary is:
Basic Salary = Gross Salary – Allowances
Difference between Net Salary and Basic Salary
In comparison to others in similar positions or ranks, the basic salary is the amount agreed by mutual consent before starting the job. It is the foundation of the salary structure.
Although your basic salary is taxable and a part of your “take-home pay,” it is not the total amount you get. Aside from that, depending on your performance or the agreement, you may be eligible for certain benefits and bonuses as an employee. The monetary value of such allowances and benefits are added to your basic pay. However, Income Tax, Professional Tax, and Provident Fund contribution amounts must be deducted from the entire amount. Net Salary, often known as “Take-Home Pay,” is the amount an employee earns after such adjustments. It is important to note that the amount of tax deducted from basic pay is not fixed and is subject to change each year depending on the tax bracket in effect at the time.
The formula to determine Net Salary from Basic Salary is:
Net Salary = Basic Salary + Allowances – Deductions from Tax and EPF.
What is Net Salary?
Net salary, also sometimes known as “take-home pay,” is the amount received by an employee in exchange for his or her services during a pay period. After deducting tax and provident fund contributions, the amount of net salary is computed by adding allowances and bonuses to the basic salary. The sum is usually less than gross salary and is calculated by deducting tax and EPF contributions from gross salary.
Net Salary = Gross Salary – Income Tax – Professional Tax – EPF contribution
What is Dearness Allowance?
Dearness Allowance, or DA, is one of the most common government benefits for employees. Dearness Allowance, formerly known as “Dear Food Allowance,” is a stipend given to employees to help with living expenses. Since this allowance is based on the cost of living, it differs for various employees depending on where they live. The sum is higher for those who live in cities compared to those who live in suburbs and rural areas.
Dearness Allowance is calculated as a fixed percentage of an employee’s basic wage. As a result, it is vulnerable to change with a hike in basic pay.
What is House Rent Allowance?
HRA, or House Rent Allowance, is for living expenses in rental housing. The company has the option of paying an employee’s rent for the time they work for them. This is referred to as the House Rent Allowance. House Rent Allowance, unlike Dearness Allowance, is not calculated as a proportion of basic pay and so is not affected by inflation.
How to calculate HRA exemption?
House Rent Allowance is decided by the organisation in respect of the amount paid by the employee as rent and added to his basic pay. Under Section 10(13a) of the Income Tax Act, 1961, a part of House Rent Allowance is exempt from tax. The exempt part is calculated as the least of the following three options:
- House Rent Allowance received as a part of salary
- 50% of Basic Salary (if the rented accommodation is in Delhi, Chennai, Kolkata, or Mumbai else 40%)
- Rent paid – 10% of Basic Salary
A is an employee who resides in a rented house in Mumbai and pays 12,000 INR as monthly rent. He receives 40,000 INR as his basic salary. He also received 15,000 INR as House Rent Allowance, 5,000 INR as Travel Allowance, 4,000 INR as arrear payment, and 4,000 INR as Special Allowance. 3,000 INR and 300 INR are deducted from his payslip for EPF contribution and tax each month. We need to calculate his net salary and the exempt part of HRA.
We know that,
Net Salary = Basic Salary + Allowances – Deductions from Tax and EPF
So, Net Salary = 40,000 + (15,000+5,000+4,000+4,000) – (3,000+300) INR
= 40,000 + 28,000 – 3,300 INR
= 68,000 – 3300 INR
= 64,700 INR
Now, we know that under Section 10 (13a), the exempt part of the HRA is the least amount of the following three:
- House Rent Allowance received as a part of salary = 15,000 INR
- 50% of Basic Salary (the rented accommodation is in Mumbai) = 20,000 INR
- Rent paid – 10% of Basic Salary =(12,000 – 4,000 =) 8,000 INR
The exempt component of HRA is valued at 8,000 INR because the third option is the least among the three presented, with a value of 8,000 INR.
What is EPF?
The Employees Provident Fund and Miscellaneous Provisions Act of 1952 established the Employees Provident Fund, often known as EPF. Employees’ Provident Fund Organization, or EPFO, is in charge of keeping track of it. Organisations that work full-time with 20 employees or more are eligible to be under its coverage.
Employee wages are directed to a pension fund through this government-sponsored savings programme. Contributions to the provident fund are deducted from gross pay and accumulated, with the whole amount payable in a lump sum at the end of employment or retirement, plus interest. To be qualified, an employee must have a monthly income of less than 15,000 INR at the time of joining the organisation. If the criterion is met, the employee is automatically enrolled in the plan. If the criterion is not met, he or she may still be covered under the scheme with the agreement of the assistant PF commissioner.
Both the employee and the employer are required to contribute 12% of the employee’s base salary to the Employees Provident Fund under the plan. The rate is 10% of the basic wage for organisations covered by the scheme with fewer than 20 employees. Employees have the option of contributing more than the set sum to the Voluntary Provident Fund, or VPF. They can collect provident fund settlement if their employment ends or they retire at the age of 55.
What is Gratuity?
Gratuity is the amount provided by an organisation to employees at the end of his or her employment as a token of gratitude towards the service provided to them. In order to receive gratuity, an employee must fulfil certain conditions:
- The employee must be qualified for retirement benefits.
- The employee must be retired.
- The employee must have completed five years under the same organisation.
- The employee passes away or becomes disabled as a result of a sickness or an accident.
What is the Cost to Company?
The annual amount paid by an organisation to an employee is referred to as the ‘cost to company’, or CTC. It refers to the total cost to the company of hiring and keeping the employee. The amount includes basic salary, perquisites, allowances, deductions, mandatory contributions, and the tax paid. The formula of determining Cost to Company from Gross Salary is:
Cost to Company = Gross Salary + EPF + Gratuity
Employer contributions to the provident fund and gratuities are not included in the Gross Salary since they are not included in the total income received by employees during the designated pay period.
Ways to lawfully save money on taxes
There are several legal ways to save money on taxes. The following are a handful of them:
- One can easily claim a tax rebate by investing in various programmes such as Equity Linked Saving Scheme (ELSS), National Saving Certificate (NSC), and Senior Citizen Saving Scheme under Section 80C.
- Donating to a charity qualifies for a tax break under Section 80G.
- The principal amount of a home loan can also be deducted from taxes under Section 80C.
- Repayment of student loan interest is eligible for a tax credit.
- Tax refunds are available for a variety of personal expenses, including tuition fees for children, insurance premiums for self or family, medical care for uncommon diseases or handicapped patients, and more.
- One can request that his or her employee rearrange your wage components and incorporate more tax-saving provisions.
- If a person’s leave travel allowance is limited to AC tier 1 rail travel or economy air travel, he or she may be eligible for a tax deduction for the same.