Understanding salary components can be difficult especially if you are new to the corporate world. There is usually the confusion of understanding the calculations of your in-hand paycheck when you get an offer. This blog will help you get a better understanding of the salary components, structure and what are the things to look out for in a salary breakdown.
Table of Contents
There are two basic types of salary structuring, and businesses can choose from this according to which suits your organization the best.
In this approach, you first specify the values for each salary component and then add all of them together to calculate gross salary. For example, Basic= ₹ 2000, DA= ₹ 2000, and gross salary= ₹4000.
Bottom-up is an approach wherein the management decides the gross salary of the employee and then breaks it down into different components. For example, gross salary= ₹15000, basic = ₹10000 and DA= ₹ 5000.
This is the fixed portion of the salary. This component is exclusive of any benefits. It will vary for each individual based on several factors such as minimum wage laws, job location, experience and so on. The basic salary components are fully taxable and therefore, keeping it high will increase the tax liability such as PF and ESI. It makes up almost 40 to 60 % of the overall salary and other salary components are also calculated based on the percentage of the basic salary.
Allowances are the monetary benefits Allowances are the monetary benefits provided by employers to their employees to cover certain expenses on top of the basic salary. Some of the common allowances include:
A House Rent Allowance is a component of an employee’s income that covers the rental expenses. This component also offers tax benefits for the employees. HRA can differ according to the job location.
The least among the following can be claimed as an exemption or deduction:
- The actual HRA received by the employee.
- 50% of the basic salary in a metro city.
- 40% of the basic salary in a non-metro city.
- Actual rent paid – 10% basic salary
Dearness Allowance (DA) is a percentage of the basic salary that is paid to employees to help them through inflation. It is paid by the government to public sector employees. DA is a fully taxable component.
Leave Travel Allowance is a component offered by employers to employees for domestic travel expenses during employee leaves. Both the public and private sectors frequently include LTA in salaries; it is tax-exempt up to the actual cost of travel. It includes the common means of transportation inside the country, such as trains, airplanes, and other public transportation. Section 10(5) of the Income Tax Act, 1961 exempts from taxes the amount paid under Leave Travel Allowance.
Employers can provide employees with a conveyance allowance, also popularly known as transport allowance, to cover the cost of their travel to and from work and place of residence.
Medical allowance refers to the fixed compensation provided by the employer to the employee for their medical expenditure. It is usually issued when there is a medical expense incurred by the employee. This amount is exempt from tax for up to 15,000 per year.
This amount is deducted from an employee’s income to cover their children’s tuition, which is tax-free up to a monthly maximum of Rs. 100 per child for a maximum of two children.
These extra benefits can be customized and vary depending on the company, such as phone or travel or other similar expenses.
A gratuity is a one-time payment made to employees who have worked for their employer for at least five years. The company deducts a certain amount from the employee salary each year, which builds up over time. This accumulated amount is given out as a lump sum gratuity payment after the five-year criteria is fulfilled. In some cases, individuals can be eligible for gratuity after completion of four years and seven months as well. Usually, a gratuity is given at retirement, termination, or superannuation (eligible for pension). It is also completely free from tax.
EPF is a welfare program for employees where monthly investments are made by the employer and employee. In an organization with more than 20 employees, it is mandatory to contribute to EPF. This is aimed at providing financial security to employees for their retirement. The employer’s minimum contribution is 12% of Rs. 15,000 (they can contribute more voluntarily), and that of the employee is 10% to 12% based on their organizational criteria. It can be withdrawn upon the end of service with the company. EPF is mandatory for employees whose monthly Basic, DA, and Special allowances come upto ₹15,000.
Professional tax is a tax that state governments impose on employee income. And so, professional taxes vary from state to state. The limit is ₹ 2500 annually all over India. Employers usually withhold professional taxes from employee paychecks every month and then pay the government the total amount received on their behalf.
The Employee State Insurance Corporation, or ESIC, is a social security scheme aimed at assisting employees. A portion of the employee’s salary is deducted to provide them with medical and financial assistance. According to the ESIC Act of 1948, an organization must deduct ESIC if it has ten or more people whose gross monthly salaries are less than ₹21,000. The employee’s ESI contribution is 0.75% of gross pay, while the employer’s contribution will be 3.25%.
TDS is a method established by the government to collect taxes at the source of income. This amount deducted by the employer is known as TDS (Tax Deducted at Source). The amount of tax calculated is directly deducted from your salary and is usually 10% of the gross salary. If the TDS collected exceeds the tax payable, you may be eligible for a TDS refund. When the tax deducted does not match the actual liable tax, you can file an income tax return (ITR) and claim a refund.
The Labour Welfare Fund (LWF) is a program that guarantees social security and employee welfare. It was established under the provisions of 1947 Industrial Disputes Act with the goal of improving the standard of living and employment of laborers. The percentage of contributions and the deduction cycles like annual, half-yearly, or monthly are determined by the State Labour Welfare Board and differs from state to state.
Overtime pay is the rate of remuneration that employees receive for working additional hours in addition to their regular working hours. Overtime pay is designed to offer fair compensation for employees for their efforts. The amount of remuneration received can vary across each organization and according to the type of work as well.
Perquisites are non-monetary perks provided to employees based on their official position in the company. This includes any additional benefits, like a company car, internet service, or accommodation, among others.
Arrears refers to payments made to an employee after the scheduled date of payment. Salary arrears are overdue amounts that are often delayed due to computational errors or other reasons. For example, an employee gets a hike in salary, but the hike is only credited to the employee in the following month. This due amount is paid later after salary restructuring in the form of salary arrears.
Companies frequently offer bonuses to recognize and reward exceptional employee performance. Businesses generally share their profits with employees in the form of bonuses to recognize their efforts in helping the company meet its targets. It is paid in addition to the salary and is a taxable component of their pay structure. Every company is obligated to provide a minimum bonus of 8.33% of the employee’s income during the accounting year or Rs. 100, whichever is higher.
The National Pension Scheme India or NPS is a scheme established by the Government of India to allow individuals to save money that can be paid out as a lump sum as a retirement corpus. Employees can withdraw upto a certain percentage of this lump sum and will receive the remaining amount as a monthly pension after retirement. Employees earning up to ₹50,000 annually should provide at least ₹6,000. The employer must also contribute 10% of the employee’s base salary to NPS. PayWheel offers NPS deduction with customizable percentage. This percentage will be automatically deducted from the employee salary and will be reflected in their payslip as well.
To understand salary calculations, you must be aware of the three basic components of salary, that is basic salary, allowances and deductions. There are also three key metrics that are most measured, which are gross salary, CTC and net salary.
Gross salary is calculated by adding your basic salary and allowances before any deductions. It includes bonuses and overtime pay, among other allowances. The formula for gross salary calculation is:
Gross Salary = Basic Salary + HRA + Other Allowances
The CTC is an employee’s total cost to the organization, which includes salary and other indirect benefits. CTC is used as a benchmark for salary while hiring new employees. The formula for calculating the CTC is:
CTC = Basic salary + Benefits + PF
Net salary, or take-home salary, is the amount an employee receives after all deductions. It is also commonly referred to as the in-hand salary. The formula for calculating net salary is:
Net Salary = Basic Salary + Allowances – (Provident fund + Gratuity + TDS + Professional Tax)
The fully taxable components in salary include:
- Dearness Allowance (DA)
- Entertainment Allowance
- Overtime Allowance
- City Compensatory Allowance
- Tiffin/Meals Allowance
- Interim Allowance
- Cash Allowance
- Project Allowance
- Non-practicing allowance
- Warden allowance
- Servant allowance
The partially taxable components include:
- House Rent Allowance (HRA)
- Leave Travel Allowance (LTA)
- Conveyance Allowance
- Medical Bills
- Reimbursement Allowance
- Education Allowance
- Hostel Allowance
- Special Allowance
CTC, or cost to company, refers to the total sum of all costs, which includes allowances and other components. However, the in-hand salary refers to the amount the employee receives each month after all the deductions.
The salary structure can seem complicated at first, but understanding the components of salary is important for employees. This understanding allows individuals to fully recognize the benefits provided by the company as well as the deductions and taxes for which they are liable. Understanding salary components can also help you make informed financial decisions in the future. However, as an HR professional, manually calculating these components can be challenging. With an HRMS software solution like PayWheel, you have the flexibility to create unique salary structures and components that align with your organizational policies. You can define values, percentages, or formulas for salary setups and configure parameters specific to your organization. PayWheel also has a reverse CTC feature, which allows HR professionals to define the salary changes for each employee, customize individual components, and access downloadable reports.
