Section 16 of the Income Tax Act, 1961

What is Section 16 of the Income Tax Act, 1961?

Section 16 of the Income Tax Act provides tax deductions on salary income to reduce your taxable income. It includes:

• Standard Deduction: A flat deduction of ₹50,000 for salaried individuals under the old tax regime. The standard deduction in the new tax regime is ₹75,000 for FY 2024-25. 

• Entertainment Allowance: Deduction for government employees only, up to a specified limit.

• Professional Tax: Deduction on any tax paid to the state on employment.

These deductions under Chapter IV of the Income Tax Act, help lower tax liability, making salary income tax-efficient. 

NOTE: Use an income tax calculator to estimate savings accurately under both tax regimes.

Three Types of Deductions under Section 16

Section 16 of the Income Tax Act provides three different types of tax deductions on salary income. These deductions help lower the tax liability. The deductions under Section 16 include the following:

• Standard deduction u/ Sec 16(ia)

• Deduction for entertainment allowance u/ Sec 16(ii)

• Deduction for professional tax u/ Sec 16(iii)

You will learn about these deductions u/ Section 16 in the following subsections.

1. Standard Deduction under Section 16 (ia)

   The standard deduction under Section 16(ia) was introduced to simplify tax calculations for salaried individuals. It allows a fixed deduction from gross salary, reducing taxable income without requiring specific expense documentation.

   Standard Deduction Amount for FY 2024-25 (AY 2025-26)

   Every financial year, a salaried individual can claim the lower amount as the standard deduction from the following:

   • The actual salary amount, or

   • The standard deduction, which is ₹50,000 (old tax regime) and ₹75,000 (new tax regime)

   KEY POINTS TO REMEMBER:

   • The deduction u/ S 16 is separate from the tax benefits under Section 80C of the IT Act.

   • The Union Budget 2024 increased the standard deduction for the new tax regime from ₹50,000 to ₹75,000 under Section 16 of the IT Act, 1961.

   Illustration of Standard Deduction Calculation for FY 2024-25:

   Particulars	Old Tax Regime (FY 2024-25)	New Tax Regime (FY 2024-25)
   Basic Salary + Dearness Allowance	₹9,00,000	₹9,00,000
   (-) Standard Deduction (on salary)	(-) ₹50,000	(-) ₹75,000
   Total Income	₹8,50,000	₹8,25,000
   (-) Other Deductions (e.g. Section 80C/ 80E/10(10D)/ 80CCB(1), home loan interest)	(-) ₹3,00,000	(-) ₹0
   NPS Deductions under Section 80CCD	(-) 50,000	(-) 50,000
   Income Chargeable to Tax	₹5,00,000	₹7,75,000
   Calculated Tax (for AY 2025-26)	₹22,500	₹32,500
   (+) Cess @ 4%	(+) 900	(+) 1,300
   Total Tax Payable	₹23,400	₹33,800

   RESULT: The above table indicates that the old tax regime is more beneficial when you are investing in various tax-saving instruments. However, the new tax regime is better if you do not want the hassle of making tax-saving investments and prefer simplified tax slabs.

   

2. Entertainment Allowance under Section 16 (ii)

   Entertainment Allowance under Section 16(ii) is a tax deduction exclusively available to government employees. This deduction aims to cover expenses related to entertainment duties as part of their job. Only government employees (Central and State Government employees) are eligible to claim this deduction under Section 16, i.e. private sector employees are not eligible.

   1. Entertainment Allowance for Government Employees (i.e., an employee of the State or Central Government):

      The deduction amount is the least of the following:

      • Actual Amount of Entertainment Allowance Received: The amount provided by the employer as an allowance.

      • 20% of Basic Salary: 20% of the employee’s basic salary (excluding other allowances and perquisites).

      • ₹5,000: Fixed maximum cap for the deduction.

      KEY POINTS TO REMEMBER: 

      • This deduction is only available with the old tax regime.

      • The 'salary' of an individual for this purpose excludes the benefits, allowance, and other perquisites.

      • Section 16(ii) is not an exemption but a deduction; the amount is first added to the salary as income and then deducted under Section 16(ii).

      • The actual amount that is expended towards the entertainment (out of the allowance of entertainment received) is not considered.

      • The deduction is calculated based on the allowance amount received and not on the amount spent. 

   2. Entertainment Allowance for Non-Government Employees (Including the employees of Local Authority and Statutory Corporations):

      The entertainment allowance is not deductible in this case. Deduction u/S 16 (ii) is not available for any other employees except government employees. If the employer pays an entertainment allowance, the complete allowance received is added to the individual's taxable income and taxed at the respective income tax slab rate.

3. Professional Tax/ Tax on Employment under Section 16 (iii)

   Professional Tax, also known as Tax on Employment, is a tax levied by State Governments on income earned by employees, professionals, traders, and others. Section 16(iii) allows salaried employees to claim a deduction for the amount of professional tax paid, thereby reducing their taxable income. This tax is applicable only in states where professional tax is levied (e.g. Karnataka, Maharashtra, and West Bengal). Also, any state government is not eligible to levy more than ₹2,500 annually as professional tax. 

   KEY POINTS TO REMEMBER:

   • The deduction for professional tax under Section 16(iii) is only available for those who opt for the old tax regime. 

   • Employers often deduct professional tax directly from the salary and remit it to the state government.

   • Professional tax paid during a financial year is deductible in the same year, reducing taxable income for that period.

   • If an employer pays the professional tax on behalf of an employee, then it is included in the employee's salary under 'perquisite,' and after that, the equal amount is allowed as the deduction under the head 'professional tax' of the salary.  

Deductions under Section 16 with New Tax Regime

The new tax regime excludes entertainment allowance and professional tax under Section 16, which are allowed to reduce from the taxable income in the old regime. 

1. Deductions Available under Section 16:

   • Standard Deduction: ₹75,000 deduction is applicable from your salary income.

2. Deductions NOT Available under Section 16:

   • Entertainment Allowance: Deduction allowed only for government employees in the old regime is also excluded.

   • Professional Tax: Deduction for state-imposed tax on salaried individuals is not applicable.

Benefits of Section 16 under Old vs New Tax Regime

The main benefits under Section 16 that show key differences between the old and new tax regimes are mentioned in the following table:

Conclusion:

As a salaried individual, you need to understand the meaning and importance of Section 16 of the Income Tax Act, 1961.  This section deals with the provisions related to the deduction of salaries and its components for tax purposes. Section 16 outlines the rules for calculating taxable income from salaries. You can make the maximum use of the deduction u/S 16 to lower your taxable income, reducing your tax liability.