Income tax on Bonus vs. fixed salary

Note: This pertains only to Indian personal income tax laws.

Do you know that your bonus payout is taxed at a different rate than your fixed (monthly salary)?

Here is how:

Your bonus is always taxed at your highest tax bracket, while there are various exemptions available which are tax exempt.

  1. Your HRA would be 40-50% of your basic. This is tax exempt if you have the proper rental receipts.
  2. Employer’s contribution would be 12% of your basic which does not even show up in your IT records.
  3. Based on company policy your LTA would be a % of your basic which is also tax exempt. (Say 2%)
  4. There are telephone reimbursements, fuel, company car lease and other mechanism that are tied to your basic pay on which you can save taxes.

So 50-64% of your basic salary is tax free. Assuming your basic compensation is 50% of your gross compensation (may vary based on company policy) this translates into 27-32% of your fixed salary being tax exempt.

This means that rather than a popular myth of income tax being 30%+ surcharge, your effective income tax on any increments (in your fixed salary) would be mere 20-22%

IT department is not so kind with bonus: So 1L of bonus taxed at 30% leaves you with 70K, while 1L of additional fixed salary would leave you with 80K extra take home. (~15% higher)

Other merits of having high fixed salary (rather than bonus):

  1. Since fixed salary is paid out monthly (rather than yearly/periodically), it eases your liquidity and ability to meet your regular expenses esp. home loan EMI.
  2. Some cheap companies show bonus as Maximum pay-out to employee rather than the normal. Which means that 15-25% of your bonus never reaches you.
  3. If you quit your job in the mid-year, no private company pays you your due share of the bonus. Hence it’s always beneficial to minimize the receivables.
  4. Gratuity/severance payouts are on the basis of your fixed
  5. Your bank loan eligibility limit is determined on your monthly take home. So high fixed component makes it easier to buy that bigger car/home that you always dreamed of.
  6. Also its beneficial to prepay the loan with a higher EMI, rather than using Bonus to pre-pay (as there are pre-payment penalties etc which you can avoid)
  7. At 9% interest rate, and assuming that the bonus is paid annually at the end of the year, you would lose about 4.5% as interest/time value of money alone. Again some cheap companies will wait for a full quarter before the bonus is paid our. (i.e. the Bonus is evaluated on your performance Jan 2015-Dec 2015 but paid on 1st April 2016.)

Bonus payouts are also not without merits:

1 Since bonus is often tied to the performance levels (personal + team + corporate), there is usually a very high chance to achieve higher bonus.

2 Being paid as a lump sum amount, it is a great morale boaster. It really helps you make the purchase/investment that you always wanted to.

3 Many companies use bonus as a retention tool, as employees usually wait till the Bonus payouts before expressing their desire to quit. Hence lesser value of the bonus, the more control you would have over the timing of the exit.

Hence don’t fall into the CTC (cost to company) trap; always calculate your salary on the basis of BTE (Benefit to employee) basis. A 119% bonus payout at the end of the year is financially equivalent to the same amount being added to your fixed salary. (15% +4.5%)

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2 thoughts on “Income tax on Bonus vs. fixed salary

  1. Hi,

    Every year I am getting a Fixed Bonus 50 K in two parts 25 K every 6 months, Wahat is the percentage rate on this 25K. Is it 30% ?

    Like

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