Taxpayers are usually aware of deductions under Section 80C of the Income Tax Act or which they are eligible. However, it is noticed that taxpayers are unaware of 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 of many allowances. Allowances are the financial benefit given to the employee over and above the monthly salary, and hence these are also known as salary allowances. Allowances are particular in nature and are provided to meet the specific requirements of employees.

Most of the times, employees often get confused between ‘Allowances’ and ‘Perquisites’, failing to understand the basic difference between the two . However, it’s important to comprehend that all allowances are not taxable. As an employee, you must know which allowances in the salary slip are actually taxable. This would help you save taxes most efficiently.

How Many Types of Allowances Are Present?

As per the Income Tax Act, allowances are broadly divided into three categories: -

Taxable Allowance 

Taxable allowances are those allowances which are part of salary and are not exempted under any section of Income Tax Act. These are taxed as per the tax slab of the employee. Here are few commonly known taxable allowances:

  1. Dearness Allowance: Dearness Allowance is mostly paid to   employees over the basic salary to manage inflation and as an adjustment towards the cost of living expenses. The income tax act clearly mentions that tax liability for Dearness Allowance will be calculated along with salary. Therefore, one must declare the same while filing income tax returns.
  2. Entertainment Allowance: This allowance is paid to employees for the expenses incurred towards hospitality of their customers for meals, drinks, hotels, client meetings and more. This allowance is completely taxable for private employees.
  3. Medical Allowance: This allowance is paid for the medical expenses incurred by the employee. This was partially exempted (Up to Rs. 15,000) till last year, however, from FY 2018-19 this allowance is fully taxable  

The other allowances which are taxable in nature are:

Interim Allowance, Tiffin / Meal Allowance, Project Allowance, Cash Allowance, Servant Allowance, Project Allowance, Telephone Allowance, Holiday allowance, Overtime Allowance and City Compensatory Allowance.

Non-Taxable Allowance

These allowances are part of the salary, however, are fully exempt from tax, which means while computing tax these are deducted from the salary. Here are few commonly known fully exempted allowances –

  1. Uniform Allowance: This allowance is paid to the employees to meet the expenses incurred on the purchase of uniform to wear during duty hours. This is exempted to the limit of the actual amount spent on the expenses.
  1. Entertainment Allowance: As explained earlier this allowance is paid to employees for the expenses incurred on the meal, hotel, etc. for the business clients or on the hospitality of the customers. This is fully exempt only for the government employees.

The other allowances which are tax free in nature are Daily Allowance, Academic / Research Allowance, Entertainment Allowance (Govt. Employees), Allowances paid to UNO Employees, Allowances paid to Judges of High Court and Supreme Court, Allowances paid to government employee posted outside India, Compensatory Allowances paid to Judges, Helper Allowance and Travelling Allowance.

Partially Taxable Allowances

These allowances are exempt from tax to a certain limit as instructed in the income tax act. Here are few commonly known partially taxable allowances:

  1. House Rent Allowance: This allowance is offered to meet the rent expenses of the employee. As per the Sec 10 (13A), the least of the following is exempted, and rest amount is taxable.
  1. Actual HRA received
  2. Rent Paid – 10% (Basic + DA)
  3. 40% of Basic + DA (50% in metro cities)


  1. Children Education Allowance: This allowance is granted towards the expenses incurred on a child’s education. This is exempted up to Rs. 100 per month per child up to a maximum of 2 children.
  1. Hostel Expenditure Allowance: This allowance is granted to employees for the expenses incurred on the hostel fees of their child. This is exempted up to Rs. 300 per month per child up to a maximum of 2 children.

How Can We Use Allowances to Save Tax?

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

Salary restructuring is not possible in every organisation, but if possible, employees should try to include allowances which 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.