Ever wondered how is salary tax calculated in India? Understanding payroll taxes is essential for employees and employers alike. Payroll tax is not just a single deduction, it is a combination of various components including income tax, provident fund and professional tax.
In this blog, we'll break down the entire process for you. Whether you're an HR professional, a small business owner or just a salaried individual wanting to understand your payslip better, this guide will help you decode how to calculate payroll efficiently. We'll also explore common payroll mistakes, challenges and some best practices to keep your payroll management accurate and compliant.
How is payroll tax calculated?
To grasp how to calculate payroll taxes, you need to understand the elements involved.
- Income Tax (TDS): Deducted at source based on your salary slab
- Employee Provident Fund (EPF): Both employee and employer contribute
- Professional Tax: Deducted by some states as per slabs
- Employee State Insurance (ESI): Applicable if the salary is below a certain limit
- Gratuity and Bonus: Not monthly deductions but part of cost-to-company
Each of these components follows a different calculation logic and statutory requirement. That's why how much tax is deducted from salary may differ based on income level, location and organisation policy.
Steps for calculation of payroll taxes
Let’s walk through how to calculate payroll taxes manually with a simplified and detailed step-by-step process.
Step 1: Determine gross salary
Start by calculating the gross monthly salary. It includes:
- Basic pay
- House Rent Allowance (HRA)
- Special allowances
- Bonuses (if any)
- Leave Travel Allowance (LTA)
- Conveyance Allowance
The sum of these components gives you your gross salary.
Step 2: Calculate taxable income
To compute your taxable income:
- Add all salary components
- Subtract exemptions like:
- HRA under Section 10(13A)
- LTA if bills are submitted
- Food coupons or vouchers within limit
- Subtract deductions under Chapter VI-A:
- Section 80C (PF, LIC, ELSS etc.) – up to Rs 1.5 lakh
- Section 80D (Health Insurance Premiums)
- Section 80E (Education Loan Interest)
You now have your net taxable income.
Step 3: Apply income tax slabs
Use the latest income tax slab (old or new regime based on employee declaration) to calculate the tax liability. Divide the annual tax by 12 to get the monthly TDS.
Income Tax Slabs FY 2024-25
Be sure to consider:
- Rebate under Section 87A if applicable
- Education cess at 4%
This TDS is what gets reflected in Form 16 and is essential for filing Income Tax Returns (ITR).
Step 4: Deduct employee provident fund (EPF)
EPF is mandatory under the Employees' Provident Fund and Miscellaneous Provisions Act for organisations with more than 20 employees.
- Employee contribution: 12% of basic + DA
- Employer contribution: 12% of basic + DA (split into EPF and EPS)
EPF is not just a deduction—it’s also a retirement savings tool. Interest earned on EPF contributions is tax-free up to a limit.
Step 5: Deduct professional tax
Professional tax is a state-imposed tax and varies by salary brackets. It is levied in states such as:
- Maharashtra
- Karnataka
- Andhra Pradesh
- Tamil Nadu
For instance, in Maharashtra:
- Salary up to Rs 7,500: Nil
- Rs 7,501 to Rs 10,000: Rs 175 per month
- Above Rs 10,000: Rs 200 per month (Rs 300 in February)
This is different from a professional indemnity insurance policy, which protects professionals in case of claims made by clients for negligence, errors or omissions in the services or advice they provide. It also helps cover legal costs, settlements or damages resulting from professional mistakes or failures.
Step 6: Deduct employee state insurance (ESI), if applicable
Applicable under the Employees' State Insurance Act for those earning below Rs 21,000/month:
- Employee: 0.75%
- Employer: 3.25%
This deduction ensures access to medical care, disability benefits, maternity cover and more.
Step 7: Deduct other benefits or reimbursements
Other salary components may include:
- Salary advances
- Meal coupons
- Loans or EMI recoveries
- Uniform allowance
- Mobile reimbursements
Step 8: Calculate net salary
Use the formula:
Net Salary = Gross Salary - (TDS + EPF + ESI + Professional Tax + Other Deductions)
And there you have it—how do you calculate payroll in India with accuracy.
Common payroll challenges & best practices
Payroll processing is more than just number-crunching. It has real legal, operational and reputational implications. Let's dive into some issues and practical solutions.
Common payroll challenges
- Changing tax laws: India’s tax structure sees frequent updates, especially with new tax regimes.
- Manual errors: A wrong PAN entry or incorrect deduction can lead to penalties.
- Non-compliance: Delays in depositing TDS, EPF or ESI attract heavy fines.
- Data security risks: Payroll data is sensitive and needs robust protection.
- Miscommunication: Employees often don’t understand why certain amounts are deducted.
Best practices for payroll calculation
- Automate payroll using reliable software
- Ensure statutory compliance by staying updated with Labour Law changes
- Conduct regular audits to identify gaps
- Train HR and finance teams to handle payroll better
- Document all declarations and proofs for tax-saving investments
- Clearly explain payslips to employees and address their concerns
Conclusion
Understanding how to calculate payroll taxes isn’t just about maths—it’s about compliance, transparency and employee trust. Knowing how is salary tax calculated and how to calculate payroll taxes manually helps employers maintain accuracy and ensures employees aren’t left in the dark.
With changing tax norms and growing employee expectations, getting payroll right has never been more important. And remember, it’s always a good idea to explore additional cover like a professional indemnity insurance policy, especially if you’re in a high-risk or client-facing profession.
Disclaimer: The information provided in this blog is for educational and informational purposes only. It is advised to verify the currency and relevance of the data and information before taking any major steps. Please read the sales brochure / policy wordings carefully for detailed information about on risk factors, terms, conditions and exclusions. ICICI Lombard is not liable for any inaccuracies or consequences resulting from the use of this outdated information.