While it’s a great feeling to receive a bonus, it can also come with a significant tax bill. So, wondering how to save tax on bonus income, is obvious.
With proper planning and understanding of tax laws, you can reduce your tax liability and maximize your bonus earnings. Let’s learn how exactly you can do that.
Tax Implications of Bonus Income in India
In India, bonuses received by employees are fully taxable. Receiving a bonus can significantly affect an employee’s overall tax liability.
Let’s take a quick overview of the same:
Common Types of Bonus
- Annual Bonus: Based on overall company performance, usually linked to profit-sharing and can vary depending on the company’s success.
- Spot Bonus: One time bonus awarded for exceptional performance on specific tasks.
- Signing Bonus: Offered to new employees as an incentive to join the company.
- Retention Bonus: Designed to keep key employees from leaving.
- Festival Bonus: Given during major festivals like Diwali, New Years, as goodwill gestures.
How & When is Bonus Taxed?
For tax purposes, bonuses are considered part of an employee’s salary and are taxed accordingly. Here’s what you need to know:
- Taxation Timing: Taxed in the financial year they are declared, regardless of when they are actually paid. For example, if a bonus is declared in March 2025 but paid in April 2025, it is still considered part of the income for the financial year 2024-2025.
- Tax Calculation: The bonus amount is added to the employee’s gross salary for that financial year. This may sometimes push the employee into a higher tax bracket, leading to increased tax liability.
- Tax Rate & Filing: Bonuses are classified as “Income from Salary” under Section 17 of the Income Tax Act. This means that they are subject to the same tax rates applicable to regular salary income.
- TDS (Tax Deducted at Source): Employers calculate TDS on the combined amount of salary and bonus.
How to Save Tax on Bonus Income: 12 Tax Saving Tips
You can adopt the following strategies to reduce tax on bonus income:
- Maximize Section 80C Deductions
If you select the old tax regime, you can claim deductions on investments in specified financial instruments, such as PPF, ELSS, and life insurance premiums.
This can effectively reduce taxable income, especially when receiving a bonus.
- Increase Contributions to EPF/ VPF:
Again, with the old tax regime, contributing more to the Employee Provident Fund (EPF) or opting for Voluntary Provident Fund (VPF) can provide tax benefits under Section 80C.
This not only helps in saving tax but also builds a retirement fund.
- Claim Section 80D Deductions
You can also claim deductions for health insurance premiums paid for yourself, family, and parents, with limits up to INR 25,000 or INR 50,000 for senior citizens.
This deduction helps lower taxable income based on health expenses. However, it is not available under the new tax regime.
- Leverage Section 80E Deductions
It allows deductions on interest paid for loans taken for higher education, with no upper limit on the amount.
The deduction is available for up to eight assessment years from the year interest payments begin. However, under the new tax regime, this is not available anymore.
- Tax Planning
Engage in proactive tax planning throughout the year rather than waiting until the bonus is received.
This includes reviewing your total income and making timely investments to maximize deductions.
You can also seek help from trusted service providers like PKC Management Consulting.
- Utilize Ambiguity in Bonus Declaration
If your bonus declaration is unclear, you might be able to change the tax year.
Collect any documents, like memos or emails, that can depict that there is a confusion about the bonus amount or timing.
When filing your tax return, include this evidence and explain why the bonus should be taxed in the year you received it, not when it was declared.
- Contribute to the National Pension System (NPS)
Contributions to NPS are eligible for an additional deduction of INR 50,000 over and above the Section 80C limit.
This is a great way to reduce taxable income while saving for retirement.
- Claim Standard Deduction
A standard deduction of INR 50,000 is available under Section 16 of the Income Tax Act.
This can be claimed irrespective of actual expenses incurred.
- Plan Your Salary Structure
If possible, negotiate with your employer to structure your salary, to include more allowances that are exempt from tax.
This may include house rent allowance (HRA) or leave travel allowance (LTA). You can also negotiate matters pertaining to NPS Contributions.
- Consider Tax Regime Options
Evaluate whether the old or new tax regime is more beneficial based on your income and potential deductions.
The new regime has lower tax rates but fewer exemptions and deductions.
To help you make the choice, we at PKC Management Consulting can aid your decision-making with a detailed comparison of the tax implications in both the old and new regimes.
- Invest in Tax-free Bonds
If you plan to invest your bonus, consider tax-free bonds issued by government entities.
The interest earned on these bonds is exempt from tax.
However, before you go in for these bonds, keep in mind that there is a lock-in period, and the interest rates tend to be lower compared to other investment options.
- Donate to Charitable Organizations
Donations to specified charitable institutions can help you claim deductions under Section 80G.
Depending on the organization, the deduction can be 50% or 100% of the donated amount.
It’s important to ensure that you are donating to a trust registered under Section 12AA and recognized under Section 80G to be eligible for these deductions
Frequently Asked Questions
- How to avoid tax on bonus in India?
To minimize tax on bonus income, consider investing in tax-saving instruments. Planning your salary structure to include more allowances that are exempt from tax can also help reduce the overall tax burden.
- How much TDS on bonus?
The TDS (Tax Deducted at Source) on a bonus is calculated based on your total income, including the bonus amount. It is added to your gross salary, which may push you into a higher tax slab, leading to increased TDS deductions.
- Where to show bonus in ITR?
In the Income Tax Return (ITR), bonuses should be reported under the “Income from Salary” section. Since bonuses are considered part of your salary, they will be included in the total income reflected in Form 16 provided by your employer.
- How does the timing of bonus declaration affect my tax liability?
The timing of the bonus declaration significantly impacts your tax liability in India, as bonuses are taxed in the financial year they are declared, not when they are received.
- Is there any way to defer the tax liability on my bonus?
While you cannot defer the tax liability directly (unless you prove ambiguity), you can negotiate with your employer to structure your salary package to include allowances that are exempt from tax or consider timing your bonus receipt if possible.
