Salary Restructuring Mistakes That Can Increase Your Tax Bill

For salaried employees, salary restructuring is not just about deciding how much gets credited to the bank account every month. The way salary is divided into different components can also affect the tax payable, depending on the tax regime chosen.

Your salary package may include basic pay, house rent allowance (HRA), leave travel allowance (LTA), reimbursements and other benefits. But simply choosing a bigger amount under one component does not necessarily mean you will save more tax. What matters is how each component is taxed and whether you actually qualify for the available exemptions.

HRA is a good example. Many employees assume that a higher HRA automatically means a lower tax bill. It doesn’t. The tax benefit depends on factors such as the rent you pay, your salary and the rules that apply to your income.

“The tax benefit on HRA is available only if the employee meets the prescribed conditions and actually pays rent. The exemption is also subject to specific limits. Therefore, simply increasing the HRA component without considering the actual rent paid may not provide the expected tax benefit. Employees staying in their own house or not paying rent should be particularly careful about relying on HRA for tax savings,” says Harsh Rustagi, consultant , Nangia & Co LLP.

Another mistake is choosing salary components based only on their tax benefits under the Old Tax Regime without checking whether the New Tax Regime is more beneficial. The New Tax Regime offers lower tax rates but does not allow most common exemptions and deductions. As a result, restructuring salary to maximise certain exemptions may not always make sense if the employee ultimately chooses the New Tax Regime.

Employees should also pay attention to reimbursements and allowances. Some salary components may be tax-free only when specific conditions are met and the required documents or proof are maintained. Assuming that every reimbursement offered by an employer is automatically tax-free can lead to unexpected tax liability at the time of filing the return.

“Another area that is often overlooked is the treatment of perquisites and employer-provided benefits. Benefits such as a company car, accommodation or certain other facilities may have tax implications depending on the nature and value of the benefit. Accepting such benefits without understanding their tax treatment can sometimes increase taxable salary,” says Rustagi.

Employees changing jobs during the year should also review the salary structure carefully. Income from the previous employer and the new employer needs to be considered together while calculating the total taxable income. Failure to provide details of income and tax deducted by the previous employer to the new employer may result in insufficient tax being deducted during the year and an additional tax liability at the time of filing the ITR.

Finally, “salary restructuring should not be done solely for tax saving. The overall compensation package, actual cash received, employee benefits and the applicable tax regime should all be considered together. A salary component that appears tax-efficient on paper may not necessarily provide a meaningful benefit in the actual situation,” informs Rustagi.

Before choosing how your salary is structured, it helps to know how each component will be taxed. There is no one salary mix that works for everyone. What makes sense depends on your income, expenses and the tax regime you are in. Getting this right can help you keep more of your salary instead of paying tax unnecessarily.