Direct and Indirect Taxation · Salaries

Taxable and Exempt Allowances under Salary

Updated 10 October 2026 · Fact-checked

An allowance is a fixed cash amount paid to an employee on top of basic pay for a stated purpose. Most allowances, such as dearness, city compensatory and special allowance, are fully taxable. Some are exempt to a limit or to the extent spent. For HRA, exempt amount is the least of three limits.

Understand Allowances Taxable and Exempt

An allowance is a cash payment an employer gives you in addition to basic salary, to meet a particular cost such as rent, travel or children's education. It forms part of salary income. The starting rule is simple: every allowance is taxable unless a specific exemption applies.

A perquisite is different. It is a benefit or facility, such as a rent-free house or a car, given in kind or paid on your behalf. Allowances are taxed at the amount received. Perquisites are taxed at a value fixed by the valuation rules. Do not mix the two in an answer.

Some allowances are fully taxable: dearness allowance (DA), city compensatory allowance (CCA), special allowance, overtime allowance, and a general transport allowance for commuting. Some are partly exempt: house rent allowance (HRA), children education allowance and hostel allowance. Some are exempt only to the extent actually spent for official duty, such as travel, daily, conveyance, helper, research and uniform allowances.

HRA is the most examined allowance. It is exempt only if you actually pay rent. The exempt amount is the least of three figures, and the rest is taxable. Most of these exemptions are available only if you are assessed under the old regime, not the new default regime. Read the question to see which regime applies.

The exemption amounts and conditions come from the Income-tax Act, 2025 and the rules made under it. For fixed-limit allowances, the limit is as per those rules, so use the figure given in the question.

Key rules to remember

HRA exempt amount: Exempt HRA = least of (a) HRA actually received, (b) rent paid − 10% of salary, (c) 50% of salary (metro city) or 40% of salary (other city); Compute on the period for which rent was paid. Taxable HRA = HRA received − exempt HRA. Use the list of metro cities given in the rules or in the question.
Salary for HRA: Salary = Basic + DA (only if it forms part of pay for retirement benefits) + commission based on a fixed percentage of turnover; Leave out other allowances, bonus, perquisites and fixed commission.
Children education allowance: Exempt = limit per month per child as per the rules under the Income-tax Act, 2025 (use the figure given in the question), up to the number of children allowed by the rules; Any amount above the limit is taxable. Old regime. Do not rely on a remembered figure; take the limit from the question.
Hostel allowance: Exempt = limit per month per child as per the rules under the Income-tax Act, 2025 (use the figure given in the question), up to the number of children allowed by the rules; The child must be in a hostel. Old regime. Take the limit from the question.
Transport allowance for a specially abled employee: Exempt = limit per month as per the rules under the Income-tax Act, 2025 (use the figure given in the question); This is for commuting between home and office by an employee who is eligible under the rules as a specially abled person. A general commuting allowance for others is taxable.
Allowances exempt to the extent spent: Exempt = lower of allowance received and amount actually spent for the official purpose; Applies to travel or transfer, daily, conveyance (for duty), helper, research and uniform allowances. Excess is taxable.
Fully taxable allowances: DA, CCA, special allowance, overtime allowance, general transport allowance = taxable in full; Add the whole amount received to salary.

How to solve Allowances Taxable and Exempt questions

Use this order for any question on allowances. It keeps each item separate and shows the examiner your working.

1Read the regime and the facts: old or new regime, city of residence, months of employment, and whether DA counts for retirement benefits.
2List every allowance in a table with its annual amount. Convert monthly figures to the year.
3Mark each allowance as fully taxable, exempt to a limit, or exempt to the extent spent.
4For HRA, first compute annual salary for the rent period. Then work out the three limits and pick the least.
5Apply the limits for children education, hostel, transport (specially abled) and similar allowances, using the limits given in the question. Where an amount spent is given, take the lower of received and spent.
6Taxable allowance = amount received − exempt amount. Do this line by line.
7Add the taxable amounts to basic salary and perquisites in the salary computation. State briefly why each exemption was allowed or denied.

Quickest way: Three-figure HRA table and one-line sort

When to use it: Use this when the question gives HRA, rent and salary figures and time is short.

Write annual salary (basic + eligible DA) first. Take 10% of it.
Write the three figures in a row: HRA received, rent paid − 10% of salary, 50% or 40% of salary.
Circle the smallest. That is exempt. Subtract from HRA received for the taxable part.
For other allowances, sort them into three bins: fully taxable, fixed limit, to the extent spent.
Check that exempt + taxable equals the total received.

Common mistakes in Allowances Taxable and Exempt

Including all allowances, bonus or the whole DA in salary for the HRA limits.
Students treat salary as gross pay.
Fix: Use only basic, DA that counts for retirement benefits, and turnover-based commission.
Taking 10% of salary instead of deducting it from rent.
The wording of the second limit is misread.
Fix: The second limit is rent paid minus 10% of salary. If the result is negative, exemption is nil.
Claiming HRA exemption when no rent is paid.
Students focus on the HRA amount received.
Fix: Rent actually paid is a condition. If no rent is paid, exempt HRA is nil and the whole HRA is taxable.
Treating DA, CCA and special allowance as exempt.
They are confused with allowances that have a stated purpose.
Fix: These are taxable in full. Exemptions need a specific provision.
Mixing allowances with perquisites.
Both are benefits from the employer.
Fix: Cash given to the employee is an allowance. A facility or a payment made on the employee's behalf is a perquisite valued by the rules.
Using the monthly children education limit as an annual limit, or ignoring the cap on the number of children.
The limits are quoted per month per child.
Fix: Multiply the monthly limit by 12 months and by the number of eligible children, as the question states.

Worked examples

Example 1

Mr. Arun Mehta lives in Mumbai and is paid basic salary ₹30,000 per month, DA ₹10,000 per month (forming part of pay for retirement benefits) and HRA ₹15,000 per month. He pays rent of ₹14,000 per month for the whole year. He is under the old regime. Compute the exempt and taxable HRA.

Show the solution

Annual salary for HRA = (₹30,000 + ₹10,000) × 12 = ₹4,80,000.
Limit (a): HRA received = ₹15,000 × 12 = ₹1,80,000.
Limit (b): rent paid − 10% of salary = ₹1,68,000 − ₹48,000 = ₹1,20,000.
Limit (c): Mumbai is a metro city, so 50% of ₹4,80,000 = ₹2,40,000.
Least of the three = ₹1,20,000, so this is the exempt HRA.
Taxable HRA = ₹1,80,000 − ₹1,20,000 = ₹60,000.

Answer: Exempt HRA is ₹1,20,000 and taxable HRA is ₹60,000.

Example 2

Mr. Rohan Iyer, under the old regime, receives these allowances per month: DA ₹8,000, CCA ₹1,500, special allowance ₹2,000, children education allowance ₹1,200 for two children, hostel allowance ₹1,000 for one child, and transport allowance ₹1,600 for commuting to office (he is not specially abled). The question states that the exempt limits are ₹100 per month per child for children education allowance and ₹300 per month per child for hostel allowance. Compute the taxable amount of allowances for the year.

Show the solution

DA: ₹8,000 × 12 = ₹96,000, fully taxable.
CCA: ₹1,500 × 12 = ₹18,000, fully taxable.
Special allowance: ₹2,000 × 12 = ₹24,000, fully taxable.
Children education: received ₹14,400. Exempt = ₹100 × 2 children × 12 = ₹2,400 (limit as given in the question). Taxable = ₹12,000.
Hostel: received ₹12,000. Exempt = ₹300 × 1 child × 12 = ₹3,600 (limit as given in the question). Taxable = ₹8,400.
Transport: ₹1,600 × 12 = ₹19,200, fully taxable as he is not specially abled.
Total taxable = ₹96,000 + ₹18,000 + ₹24,000 + ₹12,000 + ₹8,400 + ₹19,200 = ₹1,77,600.
Check: total received ₹1,83,600 − exempt ₹6,000 = ₹1,77,600.

Answer: Taxable allowances for the year are ₹1,77,600, and ₹6,000 is exempt.

Exam tips

In MCQs, watch for the three words that change the answer: metro city, rent actually paid, and DA forming part of retirement benefits.
If rent paid is less than 10% of salary, write that exempt HRA is nil. Do not leave the step out.
For fixed-limit allowances, use the limit given in the question and state it in your working.
For written answers, show the three HRA limits in a small list. Step marks go to each limit even if one is wrong.
Give a short reason beside each allowance, such as 'taxable in full' or 'exempt to extent spent'.
State the regime you assume if the question is silent, and note that these exemptions are for the old regime.

Practice questions from Salaries

Allowances Taxable and Exempt in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Allowances Taxable and Exempt: frequently asked questions

How do I calculate HRA exemption?

Find annual salary (basic plus eligible DA and turnover-based commission) for the rent period. Exempt HRA is the least of HRA received, rent paid minus 10% of salary, and 50% of salary for a metro city or 40% for other cities. The rest of HRA is taxable.

What is the difference between an allowance and a perquisite?

An allowance is a cash amount paid to you for a purpose, taxed at the amount received unless exempt. A perquisite is a benefit or facility, such as a rent-free house or car, taxed at a value set by the valuation rules.

Are special allowances exempt from tax for salaried employees?

A general special allowance is taxable in full. Only allowances with a specific exemption, such as travel or official-duty allowances to the extent spent, are exempt. Check the name and purpose of the allowance in the question.

Is DA taxable?

Yes, dearness allowance is fully taxable. It also matters for HRA only when it forms part of pay for retirement benefits, in which case it is included in salary for the HRA limits.

Can I claim HRA exemption without paying rent?

No. Rent must actually be paid. If no rent is paid, the exempt amount is nil and the full HRA is added to salary.