Salary Taxation Under New Income Tax Act 2025 — Complete Guide for FY 2026-27

Why the New Income Tax Act 2025 Changes Everything for Salaried Taxpayers

The Income Tax Act, 2025, effective April 1, 2026, replaces the Income Tax Act, 1961 — India's most significant tax law overhaul in six decades. For salaried employees and the Chartered Accountants who file their returns, the changes are structural: new section numbers, a simplified tax year concept, revised exemption limits, and a rationalized deduction framework under the newly named Chapter VIII.

This guide walks through every salary-related provision of the new Act — what changed, what the numbers are for FY 2026-27, and how to apply the rules correctly when filing ITR.

1. What Is Taxable Under "Salaries" — Definition of Salary

The new Act retains the broad definition of salary but consolidates it under a single section. The following ten income types are taxable under the "Salaries" head:

1. Basic wages and salary
2. Advance salary (taxed in year of receipt)
3. Annuity from employer
4. Gratuity (partly or fully taxable depending on category)
5. Fees, commission, perquisites, and profits in lieu of salary
6. Pension (including family pension, which is taxable under Other Sources)
7. Leave encashment (partly exempt on retirement)
8. Annual accretion in a recognized provident fund in excess of prescribed limits
9. Transferred balances from an unrecognized provident fund
10. Contribution by the Central Government to the Pension Scheme (NPS)

2. The New "Tax Year" Concept — End of Previous Year / Assessment Year

One of the most significant structural changes in the 2025 Act is the elimination of the Previous Year / Assessment Year (PY/AY) distinction. Under the old Act, income earned in FY 2025-26 was assessed in AY 2026-27 — a dual-year system that created persistent confusion.

Under the new Act, there is a single unified Tax Year. Income earned in Tax Year 2026-27 is reported and assessed in Tax Year 2026-27. There is no separate assessment year reference.

Practical implication for CAs: When filing returns for Tax Year 2026-27 (income from April 1, 2026 to March 31, 2027), you reference the Tax Year directly — not "AY 2027-28." Tax notices, returns, and documentation will use a single year reference going forward.

3. New Tax Slabs for Salaried Individuals — FY 2026-27

The new Act retains the new tax regime as the default and removes the old regime for new taxpayers. The slabs for FY 2026-27 are:

Surcharge: 10% on tax where income exceeds ₹50 lakh, 15% above ₹1 crore, 25% above ₹2 crore (capped at 25% for all incomes above ₹2 crore under the new regime). Health and Education Cess: 4% on tax plus surcharge.

Zero tax threshold: With the standard deduction of ₹75,000 and the tax rebate under the new Act (equivalent of Section 87A), a salaried individual with income up to ₹12,75,000 pays zero income tax in FY 2026-27.

4. Standard Deduction — ₹75,000 for All Salaried and Pensioners

The standard deduction under the new Act is ₹75,000, applicable to all salaried employees and pensioners without any documentation or proof of expense. This is a flat deduction from gross salary before computing taxable income.

• Applies under both old and new regime (for taxpayers still eligible for old regime)
• Available to pensioners receiving pension from former employer
• Family pension recipients get a separate deduction: lower of one-third of family pension or ₹25,000

5. HRA Exemption — 8 Metro Cities Now at 50%

House Rent Allowance (HRA) exemption calculation remains the same formula, but the new Act expands the list of cities qualifying for the 50% HRA rate from 4 to 8 metro cities.

Cities Qualifying for 50% HRA

Original 4: Delhi, Mumbai, Kolkata, Chennai
4 newly added: Bengaluru, Hyderabad, Pune, Ahmedabad

All other cities continue to qualify for the 40% rate.

HRA Exemption Formula

The exempt amount is the lowest of:

1. Actual HRA received from employer
2. 50% of basic salary (for metro cities) or 40% (for non-metro cities)
3. Actual rent paid minus 10% of basic salary

Note: HRA exemption is only available under the old regime. Employees opting for the new (default) regime cannot claim HRA exemption — they can only claim the standard deduction.

6. Perquisites — New Valuation Rules and Increased Medical Loan Limit

The new Act revises perquisite valuation rules for several employer-provided benefits. Key changes:

• Medical loan exemption: Interest-free or concessional loans for medical treatment are now exempt up to ₹2,00,000 per year — a tenfold increase from the previous limit of ₹20,000. This covers loans for specified diseases listed in the Act.
• Accommodation perquisite: Valuation based on population-linked percentage of salary is retained but the city-tier thresholds have been updated to reflect 2021 census data.
• ESOPs: Tax on Employee Stock Option Plans for eligible start-up employees continues to be deferred to the earlier of: sale of shares, cessation of employment, or 5 years from allotment.

7. Gratuity and Leave Encashment — Revised Exemption Limits

Gratuity (Non-Government Employees)

Gratuity received on retirement, death, or resignation is exempt up to ₹20,00,000 (₹20 lakh). Any amount beyond this limit is fully taxable as salary income. The limit for government employees and employees covered by the Payment of Gratuity Act remains unlimited.

Leave Encashment on Retirement

Leave salary received on retirement or resignation is exempt up to ₹25,00,000 (₹25 lakh) for non-government employees. The exemption applies only on retirement — leave encashment during service remains taxable.

Commuted Pension

For non-government employees, commuted pension is exempt up to one-third of the commuted value if gratuity is also received, or one-half if no gratuity is received. The new Act explicitly codifies this formula that was previously derived from rules and circulars.

8. Provident Fund and NPS — Treatment Under New Regime

Employee Provident Fund (EPF)

• Employee contribution: No deduction under new (default) regime; deductible under old regime via the Chapter VIII equivalent of Section 80C.
• Employer contribution: Exempt up to 12% of salary; excess is taxable as perquisite.
• Interest on EPF balance: Exempt for contributions up to ₹2.5 lakh per year (₹5 lakh for government employees). Interest on contributions above this threshold is taxable.

National Pension System (NPS)

• Employer contribution to NPS: Deductible up to 14% of salary (increased from 10% for private sector employees — now aligned with government employees).
• Employee contribution: Deductible under old regime only (Chapter VIII equivalent of Section 80CCD(1B) up to ₹50,000 additional).
• Partial withdrawal and lump-sum on maturity: 60% of corpus exempt; 40% mandatorily used to purchase annuity (annuity income taxable).

9. TDS on Salary — New Sections and Forms

The new Act renumbers and rationalizes TDS provisions for salary. CAs managing payroll compliance must update their processes:

Employers must issue Form 130 (the new Form 16) to employees by the prescribed date. The quarterly TDS return (Form 138) filing timelines remain the same as before. The merger of 15G and 15H into a single Form 121 simplifies the process for senior citizens.

10. Chapter VIII Deductions — Replacement of Chapter VI-A

Chapter VI-A of the old Act (containing Sections 80C through 80U) is replaced by Chapter VIII in the new Act. The deductions themselves are largely carried over but renumbered. Key points for CAs:

• The Chapter VIII deductions (equivalent of 80C, 80D, 80E, etc.) are only available under the old regime. The default new regime does not permit these deductions.
• The aggregate limit for life insurance, PPF, ELSS, tuition fees, and home loan principal repayment (equivalent of old 80C) remains ₹1,50,000.
• Health insurance premium deduction (equivalent of old 80D): ₹25,000 for self/family; ₹50,000 for senior citizen parents; ₹75,000 if the individual is also a senior citizen.
• Senior citizen savings bank interest deduction (equivalent of old 80TTB): increased to ₹1,00,000 (up from ₹50,000).
• NPS additional deduction (equivalent of old 80CCD(1B)): ₹50,000 for employee contribution to NPS — old regime only.

11. Old vs New Regime — Side-by-Side Comparison

Rule of thumb: If total eligible deductions under the old regime (HRA + home loan interest + 80C + 80D etc.) exceed approximately ₹3.75 lakh for someone in the 30% bracket, the old regime may save more tax. Otherwise, the new regime's lower slab rates produce a lower tax liability for most salaried employees.

12. Salary Arrears and Relief — Successor to Section 89

When an employee receives salary arrears relating to earlier tax years — due to a pay revision, court order, or settlement — it is bunched into the current year's income and can inflate the tax liability artificially.

The new Act carries forward the Section 89 relief mechanism under a renumbered provision. The process:

1. Compute tax on total income including arrears in the current year
2. Compute tax on total income excluding arrears in the current year
3. Compute tax on total income of the year(s) to which arrears relate, with and without the arrear amount
4. The relief is the difference between (1) and (2), reduced by the excess of (3a) over (3b)

New requirement: A mandatory e-form must now be filed with the return to claim arrear relief — the manual Form 10E equivalent is replaced by an integrated electronic submission within the ITR filing portal. Ensure your clients submit this form before or simultaneously with the ITR.

13. Foreign Currency Salary — Expat and NRI Rules

For employees on foreign assignments receiving salary in foreign currency, the new Act clarifies valuation:

• Salary paid in foreign currency is converted to INR at the SBI buying rate on the last day of the month in which salary is due
• Allowances received outside India by employees posted abroad for Indian employers remain exempt, as under the old Act
• TDS on foreign currency salary: The employer deducts TDS after converting to INR using the prescribed SBI rate — this eliminates disputes that arose from different conversion rates being used

Frequently Asked Questions

Does the new Income Tax Act 2025 affect my FY 2025-26 return?

No. The new Act is effective from April 1, 2026, so it applies to income earned from FY 2026-27 (Tax Year 2026-27) onward. Your FY 2025-26 return (due July 31, 2026) is still filed under the Income Tax Act, 1961, using the rules and slabs applicable to AY 2026-27.

Is Form 16 still valid for FY 2025-26?

Yes. Form 16 continues to be issued by employers for FY 2025-26 (income up to March 31, 2026). Form 130 replaces Form 16 only for FY 2026-27 onward — the first Form 130 will be issued by employers in mid-2027 for Tax Year 2026-27 salary.

Can I still choose the old tax regime under the new Act?

The new (default) regime is the primary regime under the 2025 Act. The old regime remains available for individual taxpayers and HUFs who opt for it explicitly while filing — similar to the current opt-in requirement. However, for new taxpayers entering the system from FY 2026-27, the new regime is the default and the process to opt out should be completed by the due date of filing.

My employer is in Bengaluru — do I get 50% HRA now?

Yes. From FY 2026-27, Bengaluru is one of the 8 cities eligible for the 50% HRA rate. If you live in rented accommodation in Bengaluru and receive HRA from your employer, your exemption calculation uses the 50% rate (for old regime filers). This applies to Hyderabad, Pune, and Ahmedabad as well.

What happens to my EPF contributions under the new Act?

EPF treatment under the new Act is substantially unchanged. The key point: employee EPF contributions are deductible only under the old regime (via Chapter VIII deductions). Under the default new regime, EPF contributions earn no deduction. Employer EPF contributions up to 12% of salary remain exempt as before. Interest on accumulated EPF balance is exempt for contributions up to ₹2.5 lakh per year.

The NPS employer contribution limit increased — how do I benefit?

For private sector employees, the employer's NPS contribution that is deductible from taxable salary has been raised from 10% to 14% of salary. This deduction is available under both old and new regimes. If your employer is willing to restructure your CTC to include a higher NPS contribution, this can meaningfully reduce taxable salary — the additional 4% employer NPS contribution is not taxable as a perquisite.

Do I need to do anything differently if I claim arrear relief?

Yes. Under the new Act, claiming arrear relief requires filing a mandatory e-form through the Income Tax portal — the standalone Form 10E process is integrated into the return filing workflow. Ensure this form is filed on or before the ITR submission date. Late submission of the form after ITR filing will not be accepted, and the relief will be disallowed.

Related Reading

• ITR Filing Guide for Salaried Below ₹50 Lakh — applying these rules for FY 2025-26 returns
• ITR Filing Guide for Income Above ₹50 Lakh — surcharge and Schedule AL for high-income salaried
• Section 87A Rebate and Capital Gains — new regime rebate rules under Finance Act 2025
• Advance Tax Calculation for FY 2025-26 — relevant when salaried employees have side income
• ITR Filing Due Dates for FY 2025-26 — complete deadline guide for AY 2026-27