Optimum Salary Structure – Maximum In Hand Salary Or Minimum Tax Liability
Mohan is a 26-year-old management graduate recruited by a startup company in Mumbai recently. The company has offered him a CTC package of Rs 10 lakh. However, the company has given him the flexibility to structure the salary part of his CTC as per his requirements. How should Mohan structure his salary so as to derive maximum benefit?
Mohan needs to consider the following outflows while deciding his CTC structure:
- An annual rent payment of Rs 2 lakh
- An annual payment of Rs 1 lakh towards interest on his education loan.
Components of CTC
The cost to company (CTC) figure quoted by a company indicates the total amount of money it will spend on an employee. Some of the important heads under CTC are:
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- Basic Salary
- House Rent Allowance
- Supplementary Allowance
- Company's Contribution to Provident Fund/Gratuity
- Company's Cost on various perks
- Child Education and Hostel Allowance
- Transport Reimbursement
- Lunch Coupons
- Medical Reimbursement
- LTA Reimbursement
- Car & Driver Reimbursement
What will Mohan achieve by structuring his salary?
To structure his salary, Mohan needs to divide the Rs 10-lakh CTC under various heads that are mentioned earlier. But while doing so, he should also keep in mind his financial goals. By structuring his salary Mohan can either reduce his overall tax liability or maximise his in-hand salary.
How can Mohan minimise his taxes?
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- Utilising various deductions allowed under the Income Tax Act, to the maximum.
- Allocating the CTC amount to various tax-deductible reimbursements like transport, lunch coupons, etc.
- Splitting the CTC amount into Basic Salary, HRA and Supplementary Allowance such that tax is minimised on account of HRA exemption and Section 80C.
Mohan can avail the following deductions to reduce his taxable income:
- Rs. 1 lakh, the interest payment on his education loan, is tax-deductible under Section 80E
- Contribution to PF, up to Rs 1 lakh, is tax-deductible under Section 80C
Mohan should, thus, optimise the breakup of CTC (basic salary and PF contribution) and also his investments such that this limit is met.
II. Tax-deductible reimbursements
Mohan can claim various reimbursements that are also tax deductible. These include:
Reimbursement Tax-exempt Limit (Rs) Exemption for Mohan (Rs) Child education & Hostel allowance* 9,600 0 Transport 9,600 9,600 Lunch coupons 15,600 15,600 Medical 15,000 15,000 LTA As per claim 0 Car & Driver * 26,400 0 Total 40,200
* We assume that Mohan does not have any children and that he does not use a car. Thus, he cannot avail reimbursements under these two heads.III. Allocation of CTC
Let us now look at some possible breakups of Mohan's CTC and the tax he will be paying on each of them:
Basic Salary as a % of CTC 60% 74.5% 80% Basic salary (Rs) 6,00,000 7,45,000 800,000 House rent allowance (Rs) 2,87,800 1,25,400 63,800 Transport reimbursement (Rs) 9,600 9,600 9,600 Lunch coupons (Rs) 15,600 15,600 15,600 Medical reimbursement (Rs) 15,000 15,000 15,000 Company’s PF contribution (Rs) 72,000 89,400 96,000 Total Gross Salary (Rs) 10,00,000 10,00,000 1,000,000 Deductions Employee contribution to PF (80C) (Rs) 72,000 89,400 96,000 Interest repayment on education loan (80E) (Rs) 1,00,000 1,00,000 100,000 Annual Tax (Rs) 76,241 69,999 84,954 Unutilised deductions u/s 80C (Rs) 28,000 10,600 4,000 Tax exemption on HRA (Rs) 1,40,000 1,25,400 63,800 Taxable HRA (Rs) 1,47,800 0 0
We see that Mohan's tax liability is minimal when the basic salary is 74.5 per cent of CTC. This is the optimal percentage at which Mohan's tax liability is minimum. As we decrease or increase the basic salary from this optimal percentage, the tax liability increases. Optimal percentage is the percentage at which Mohan is getting the maximum tax benefit from exemption under HRA and deductions under Section 80C combined.
As the basic salary is decreased from the optimal percentage, employee's contribution to PF also reduces, which in turn reduces the tax-deductible income under Section 80C. This means there will be a greater taxable income and hence a greater income tax. This will lead to an increase in the tax exemption limit under HRA, which means an increase in the amount of CTC allocated to HRA and the taxable HRA. This translates into a greater tax liability.
On the other hand, when the basic salary is increased from the optimal percentage, a smaller amount of CTC is allocated to HRA and the tax benefit on HRA is not fully utilised. Also, the employee pays tax on this amount which is now allocated under basic salary. This translates into a greater tax liability.
Mohan's tax liability vs basic salary
If we were to plot a graph of Mohan's tax liability versus his basic salary as a percentage of his CTC, we get the following:
This graph shows that there is an ideal level (70%-80% of CTC) at which Mohan can minimise his tax liability. This level depends on the rent he pays, the deductions he claims and the CTC that he gets (among other things). This level will be different for different people. You can use our calculator to find the optimal CTC breakup for you.
Let us compare the optimal possibility with another possibility (A) in which Mohan decides to rent a costlier house at Rs 3 lakh and invests another Rs 30,000 into NSS (deductible under Section 80C). The new salary structure and annual tax would be as under:
Basic Salary as a % of CTC 74.5% Possibility A Basic salary (Rs) 7,45,000 6,46,000 House rent allowance (Rs) 1,25,400 2,36,280 Transport reimbursement (Rs) 9,600 9,600 Lunch coupons (Rs) 15,600 15,600 Medical reimbursement (Rs) 15,000 15,000 Company’s PF contribution (Rs) 89,400 77,520 Total Gross Salary (Rs) 10,00,000 10,00,000 Deductions Employee contribution to PF (80C) (Rs) 89,400 77,520 Interest payment on education loan (80E) (Rs) 1,00,000 1,00,000 Annual Tax (Rs) 69,999 42,123 Unutilised deductions (80C) (Rs) 10,600 0 Tax exemption on HRA (Rs) 1,25,400 2,35,400 Taxable HRA (Rs) 0 880
In possibility A, Mohan is paying significantly lower taxes because:
- Increase in annual rent paid: By renting a costlier house, Mohan is able to avail the maximum limit on tax exemption on HRA. Thus his total taxable income is reduced and so is his tax liability. In short, Mohan can stay in a better house and still pay lesser taxes!
- Increase in deduction under Section 80C: Mohan has decided to invest another Rs 30,000 in NSS. This helps him get the maximum deduction limit under Section 80C, which further reduces his tax liability.
The key to lower taxes is to utilise the total tax deduction limit available under both HRA and Sec 80C. The HRA limit can be completely utilised by paying a higher rent (as far as possible) whereas in case of the 80C limit it is done by investing into available options.Read Tax Guide
There are several options available to Mohan to invest under Section 80C. He could put his money in provident fund, insurance schemes, NSC, NSS, post office, tax-saver (ELSS) mutual funds, etc. Mohan must remember that for every rupee that he invests in PF, the company has to put in an equivalent amount. Thus Mohan gets a double benefit. For every rupee that he invests in his retirement fund, another rupee gets invested automatically. Hence if his company allows it, Mohan might want to use PF as the major head to utilise the limit under Section 80C.
How can Mohan attain a significant monthly in-hand salary?
Instead of minimising his annual tax liability, Mohan might be interested in increasing his monthly take home salary. Let us first understand the components of take home (in-hand) salary.
The monthly in-hand salary consists of:
- Basic salary
- House rent allowance
- Supplementary allowances
- Reimbursement under certain heads like transport, car and driver, etc.
From this total, contribution of the employee to provident fund, professional tax and income tax are deducted.
Let us compare Mohan's take home salary in two different salary structures: Possibility A (described earlier) and possibility B (another salary structure).
Basic Salary as a % of CTC Possibility A Possibility B Basic salary (Rs) 6,46,000 4,00,000 House rent allowance (Rs) 2,36,280 2,00,000 Supplementary allowance (Rs) 0 3,11,800 Transport reimbursement (Rs) 9,600 9,600 - Employee’s PF contribution (Rs) (77,520) (48,000) - Professional tax (Rs) (2,400) (2,400) - Annual income tax (Rs) (42,123) (56,465) Net Annual In-hand Salary (Rs) 7,43,631 8,18,182 In-hand Monthly Salary (Rs) 64,153 67,878
- In possibility B, it has been assumed that the exemption limit for 80C has been met by additional investments (similar to possibility A).
- Certain other reimbursements which are made either quarterly or annually have not been included in the monthly in-hand salary. These include:
- Child education and hostel reimbursement
- Lunch coupons
- Medical reimbursement
- LTA reimbursement
As discussed above, Mohan's tax liability is minimised in possibility A. In possibility B, he pays a marginally higher tax but at the same time takes home significantly greater salary. This is because Mohan's contribution to provident fund is reduced by almost Rs. 30,000 in option B. By choosing option B over option A, Mohan might benefit by taking home greater salary but he loses by paying greater income tax and saving less for his future. Further, the effect of reduction in PF is twofold because not only Mohan's contribution to savings is reduced but the company's contribution to PF is also reduced by an equivalent amount.
Summing it up
- To minimise taxes, Mohan needs to utilise tax exemption limits under HRA and Section 80C, to the maximum.
- Annual rent paid plays an important role in determining the overall tax liability. Higher the rent paid, greater is the salary exemptible under HRA. Mohan might be better off paying a higher rent as it would mean a lower tax liability for him. He can get the dual benefit of living in a better house and paying lower taxes at the same time.
- To utilise the limit under Section 80C, investment into provident fund will be a better option than insurance, NSC, MFs, etc. The reason: the employer has to invest an equal amount into the provident fund as the employee – which doubles the investment for Mohan. Also, the employer's contribution is tax free.
- Various allowances and reimbursements, for example, lunch coupons, transport, LTA, car & driver, etc., are a good means to reduce net taxable income and hence the overall tax liability.
- Mohan can structure his CTC to reduce his tax liability or to maximise in-hand income. In order to increase the take home salary, he has to pay a higher income tax and make lesser investments towards retirement
16 Responses to “Optimum Salary Structure – Maximum In Hand Salary Or Minimum Tax Liability”
Rohanraj said on July 6th, 2010 at 3:37 pm
this is a good article, people need to know salary breakup for maximum tax benefits and maximum in hand salary…i wish if we could get tax benefit and salary breakup calculators at our disposal. it would saveus neumerous permutation and calculations for the best result.But having said that, i have definately found this article a real class. want more of these
Anil said on July 23rd, 2010 at 3:46 pm
I found a good salary in hand calculator here:
The calculator also suggests various options on how to increase your monthly in hand salary by making full use of tax rebates.
Hope you will like it.
JAGADISH said on February 4th, 2011 at 10:20 am
MY TOTAL SALARY IS 325000
Samir Arande said on August 28th, 2011 at 12:32 pm
Please set my salary structure for CTC 910000/-
3400/- child fees, 47000/- polices & 50000/- PPF
reply me as early as possible.
joby said on October 22nd, 2011 at 10:12 pm
Dear sir, i want a breakup of 25000/month please help me for the same
tyagi said on December 9th, 2011 at 7:26 pm
I need a good salary strucuture for the following grades. For each grades net take home must be good after considering current income tax laws.
1.Management Level – CTC .Rs.1500000 pa
2. Junior Management Lel – CTC Rs.750000 pa
3. Back office Support – CTC Rs.500000 pa
Thanks and Regards
mohit c said on December 19th, 2011 at 12:14 pm
DEAR SIR. CAN YOU HELP ME IN PREPARING IDEAL SALARY BREAK UP OF RS. 25L P.A FOR MY SELF . I AM ALREADY CROSSED RS.1L FOR INSURANCE PREMIUM. I DONT HAVE ANY LOANS LIKE HOUSE / CAR ETC. I HAVE TAKEN RS.20K WORTH INFRA BONDS. HEALTH INSURANCE = 7000/PA
Mangal said on January 7th, 2012 at 12:57 pm
Absoulutely wonderful, informative and illustrative article!
Nitin said on March 1st, 2012 at 4:31 pm
I would like to bring to your kind notice one more aspect in the example given by you. While comparing the slab 74.5 % with Possibility A, Mohan is paying excess rent of Rs.110800 (236280 – 125000) and his tax liability is reduced by Rs.27827/- (69999 – 42123) only. It means for saving Rs.27827/- he is actually paying Rs.110800/- which not a good option for him. Instead in the next comparison of Possibility A and Possibility B, he will be on earning side by opting for Possibility A. Althogh by opting for A he is paying excess Rent of Rs.36000/- the amount is covered in PF and IT liabilities.
No doubt this is a very good information and explaination made available by you. Thank you. Keep sharing the knowledge.
vishan swaroop said on May 5th, 2012 at 11:15 am
I m new and i want to know the whole calculaton process of salary with %age and with all components of salary. Please help me how i calculate the all parmenters of salary to maintain the salary register
Abdul Wahid said on May 11th, 2012 at 9:26 am
My net salary ammount is 15010/ per month but my professional tex deductione in every month is 208/ Rs. per mont.how i don't know please explain me recent
professional tex limt.
kiran said on May 25th, 2012 at 7:33 pm
hra conclusion is stupid. You can pay more rent but the deduction will be according to section 10(13A) of the Income Tax Act which has got 3 clauses based on which the calaculations has to be done. Paying more rent will not bring down the tax
girish sharma said on June 22nd, 2012 at 9:34 am
Pl provide me CTC monthly salary breakup for 4 to 5 lakh gross per annum peackage.
it urgently required.
lakshmi said on July 6th, 2012 at 4:00 pm
payrole act what will be the percentage wise calculation of salary
shilpa said on July 12th, 2012 at 8:22 pm
i would like to know total salary for Rs. 13500-25520 (IDA)
Basic Pay + 35 % Perks +
prevalent DA in IDA +
30% HRA+ Site
Allowances as applicable.
Life and accident
Insurance, Group Savings
Superannuation Pension scheme…
plz provide me the dateils …. i am waiting for your positive feedback…
thanks and regards
Nagarjuna Rao said on August 24th, 2012 at 9:23 am
sir ,I am nagarjuna .I am joing in construction company as a manager with salary of 12 lakhs per anum,
company HR has given company salary structure. I would like to compare and discuss with them by taking some sugestions regarding this issue.
pl send some salary structures to my mail id