The Employee Provident Fund (EPF) is used as a retirement and tax planning instrument. It is mandatory for all employees earning more than Rs 15,000 a month and working in an organisation with more than 20 employees to contribute to EPF.
Is EPF interest tax-free? Earlier, the interest earned on EPF was tax-free. However, in the budget session of 2021-22, the government introduced 10(11) and 10(12) in the Income Tax Act of 1961. It will make the interest on EPF contributions taxable above a certain level.
What is EPF?
It is calculated based on your salary. The amount is deducted from the employee’s monthly wage towards a retirement corpus and accumulated in a particular account to be released on retirement. To know your EPF contribution, use an online EPF calculator. Until recently, the interest earned on the EPF fund was tax-free, which the government has now amended to prevent higher wage earners from exploiting tax loopholes.
We will discuss the old and the new tax regime and how it will impact the tax on EPF interest.
In the old system, the interest earned on the EPF interest was tax-free. The contribution made by the employer towards employee EPF was also exempted under IT Act.
Tax exemption on the interest of EPF was available under section 80C of the IT Act 1961. Employees received tax benefits up to Rs 1.5 lakh per year. Employer contribution was tax exempted up to 12%. Beyond that, it was taxable. The interest earned on the EPF account was tax-free.
New tax rules
In the budget session of 2021-22, the government introduced new tax laws to make the interest earned on EPF taxable. The latest changes aim to restrict high-income earners depositing over the prescribed limit from receiving unwarranted benefits.
The government has changed the highest limit for tax-free interest income for private-sector employees to Rs 2.5 lakh. Government employees, however, can deposit up to Rs 5 lakhs in the absence of employer contribution without incurring taxes. Any excess amount deposited above the prescribed limit will now be taxed. Interests earned above the threshold amount of Rs 2.50 lakh will attract 10 percent TDS.
How is the new tax on EPF interest calculated?
The tax implications will be different for private and public sector employees. Let’s clear it with the help of an example.
For instance, if a private sector employee contributes Rs 5 lakh towards EPF, under the new tax rules, he will have to pay tax on the extra Rs 2.5 lakh above the cut-off limit.
However, the situation is different for a public sector employee. If a government employee contributes Rs 6 lakh, he will have to pay tax on the excess amount of Rs 1 lakh.
Under the changed scenario, employees will have a provision to open two PF accounts – one will be a taxable account, and the other is a tax-free account.
How to calculate taxable and non-taxable contributions
The calculation involves two parts. One can use the formula below to calculate taxable income on the EPF account.
Part 1: The closing balance on the EPF account on March 31, 2022, is less than Rs 2.5 lakh or below Rs 5 for public employees, interest accrued and interest received on the contribution is below the limit.
Part 2: Any withdrawal from the PF account.
The non-taxable contribution is the aggregate of Part 1 minus Part B.
It is the aggregate of the following components.
Part 1: Any contribution made above Rs 2.5 or Rs 5 lakh as applied and interest accrued on the contribution.
Part 2: Withdrawals from the account.
The tax on EPF interest is calculated on the difference between Part 1 and Part 2.
- The new changes will apply from April 1, 2022.
- The new tax-free limit is revised to Rs 2.5 lakh per year.
- In the case of public employees, the modified limit is Rs 5 lakh.
- The tax will apply only to the excess amount.
- The employer’s contribution will remain tax-free. The tax will affect only the employee.
- The new EPF tax will apply to individuals with an annual income of Rs 20.83 lakh and above. Thereby only going to affect a few high-income professionals.
- The new policy will section PF contributions under taxable and non-taxable components. Individuals can maintain two separate accounts for taxable and non-taxable deposits.
- The new rules aim to prevent high-income earners from making significant self-contribution to their PF accounts.
With the new changes in tax on EPF interest, the government aims to broaden the tax base and improve direct tax collection. It will help tax administrators to prevent high-income earners from exploiting the loopholes and increase tax collection. Try alternative investment options if you want to lower your tax burden and earn higher profit. The current PF interest rate is 8.1 percent, the lowest in 40 years.