Income earned by an individual can be broadly classified under 5 distinct heads and taxed according to the Income tax rules governing them. The 5 heads of income are: 
Salary Income
Income from house property
Business or Professional Income
Capital Gains
Other Income 
We shall discuss in detail the first head of income namely Salary Income and how is tax calculated on the same.

What is Salary Income?
Salary means remuneration paid to the employee by the employer for the services rendered by him during a period of time. It is taxed on due basis or receipt basis, whichever is earlier. Salary comprises of 5 components namely:
Basic Salary
Fees, Commission and Bonus
Allowances
Perquisites
Retirement Benefits
Basic Salary
Basic salary is a fixed component of the salary which is agreed upon as per terms of employment or as per the graded system of salary. As per the graded system, the increments are fixed till the basic salary reaches a prescribed limit for the grade.

Fees, Commission and Bonus
Fees and bonus paid to the employee is part of taxable salary. Commissions paid to employees maybe fixed or a percentage of turnover achieved by the employee. If commission is paid a s part of percentage of turnover, the same is added to the basic salary for the purpose of computation of retirement benefits.

Allowances
Allowances are fixed amounts paid by an employer to an employee to meet his expenses for personal use or for performance of his professional duties. The allowances are over and above the basic salary and are taxable as per their nature and guidelines laid by the Income Tax Act. These allowances can be classified as:

Fully Taxable
Fully taxable allowances are as under:

Dearness Allowance
This allowance is paid to meet the mounting expenses due to inflation. In some cases it forms part of basic salary for computing retirement benefits.

City Compensatory Allowance
This allowance is paid to employees who are transferred to big metros like Mumbai, Delhi, and Chennai where the cost of living is higher than other cities.

Overtime Allowance
Any allowance paid for working over and above the prescribed hours is called overtime allowance and is fully taxable

Other Allowances
There are many other allowances that are taxable such as deputation allowance, servant allowance, etc.

Partly Taxable
Partly taxable allowances are as under:

House Rent Allowance (HRA)
This allowance is paid to the employee to meet the rental expenses for residential accommodation for self. If the employee lives in his own house, then the HRA is completely taxable. The exemption amount of HRA for rental property is least of the following:
Actual HRA
Additional rent paid over and above 10% of salary due to him
An amount equal to 50% of salary due to him if living in metros (40% of salary if living in other places)
Entertainment Allowance
This allowance is first included in the salary and is then allowed as an exemption only to Central and State Government employees.

Special Allowance
This allowance is given to the employee for carrying on his official duties and is exempt to the extent it is actually incurred. This includes uniform allowance, travel allowance, research allowance, etc.

Special Allowance to meet personal expenses
A fixed allowance is paid to the employee to meet his personal expenses. This allowance is fixed and a reimbursement of the entire expenditure incurred. Eg: Children Education Allowance, Children Hostel Allowance, etc.

Fully Exempt
Fully exempt allowances are as under:

Foreign Allowance
Allowances given to employees posted abroad for carrying out their professional duties are completely exempt from tax

Allowance given to High Court and Supreme Court Judges
Allowances of any kind given to High Court and Supreme Court judges are completely exempt from tax

Allowance given to UNO Employees
Allowances given to employees of United Nations Organisation are completely exempt from tax.

Perquisites
Perquisites are emoluments received by an employee by virtue of holding the position and office over and above his salary. They benefit the employee and are not just reimbursement of expenses. These benefits are also in kind and can be valued. Perquisites can be again classified under three heads:

Perquisites that are taxable for all employees: Some perquisites that are taxable for all employees are: 
Rent free accommodation
Concession in rent of accommodation
Interest free loans or subsidized loans
Movable assets or transfer of assets
Payment of club fees
Payment of educational expenses
Payment of insurance premium, on behalf of employees
Perquisites that are taxable only for specified employees
Specified employees are employees who are either directors in the organization or have substantial interest in the organization or their salary was over Rs.50000/- in the previous year:
Free gas, electricity, water supply for domestic purposes
Free or concessional educational expenses
Gardener, sweeper, attendant
Free or concessional transport facility
Any other benefit or amenity
Perquisites that are exempt from tax
Some perquisites are notified by the Income Tax Departmentwhere fringe benefit tax has to be paid by the employer on the expenses incurred by them on the perquisites. These fringe benefits are absolutely exempt from tax in the hand of the employee. These include:
Medical Benefits
Leave Travel Concession
Health Insurance Premium
Car, laptop, computers for personal use
Staff Welfare Schemes
The perquisites which are taxable are valued as per the rules laid down in the Income Tax Act.
Retirement Benefits
These benefits are provided either at the time of retirement or during the period of the service. Each benefit has a different tax treatment. The various benefits are:

Pension
Pension is a reward for the services rendered by the employee> It is usually disbursed as a monthly payment, but sometimes the employee may opt for a lumpsum payment. The tax treatment depends on the option chosen and on the category of employee.

Gratuity
Gratuity is a payment received in appreciation of past performance. It is received on retirement. It is exempted upto a certain limit and also dependent on the type of employee.

Leave Salary
Privilege leave is accumulated in the account of the employee. The employee may avail of leave or may opt for encashment of leave accumulated. This is permitted either during the tenure of service or at the time of retirement. The tax treatment will depend on the option chosen and on the category of employee.

Provident Fund
Contribution towards Provident fund is deducted on a monthly basis from the salary of the employee. An equal amount is also contributed by the employer. At the time of retirement the accumulated balance in the Provident fund account along with the interest is given to the employee. The tax treatment of the proceeds depends on the type of provident fund maintained by the employer.

Deductions allowed from Salary: The following deductions are made from the salary income to reach the net salary income:

Standard Deduction: This deduction has been discontinued from Assessment year 2006-07

Entertainment Allowance: This is first included in the salary and then allowed as a deduction to the State and Central Government employees. The deduction amount is the least of
Rs.5000/-
Entertainment allowance actually received
20% of basic salary
Professional Tax: Professional tax also known as tax on employment is first paid by the employer and then allowed as a deduction from salary. It is allowed only in the year in which it is actually paid.

Computation of Net Salary of an Employee

Particulars	Amount (Rs)
Basic Salary
Fees Commission and Bonus
Allowances
Perquisites
Retirement Benefits
	-------------------
Gross Salary	-------------------
Less: Deductions from Salary
Standard Deduction
Entertainment Allowance
Professional Tax
	-------------------
Net Salary	-------------------

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