What Is Payroll Tax? Definition, Types, and Examples Explained

If you ask ten people in India what “payroll tax” means, I’m pretty sure that you’ll get ten different answers. Some will say TDS. Others will say PF. A few will also mention professional tax.

None of them are completely wrong, and none of them are completely right either.

That’s because “payroll tax” isn’t really an Indian term. In the US, it has a specific legal meaning. In India, it’s a catch-all for everything an employer withholds from a salary before it lands in the employee’s bank account, income tax, social security contributions, and state-level levies, all rolled into one phrase.

This terminology gap is why most articles online get it wrong. And it matters, whether you’re running payroll or just reading your payslip.

According to PwC’s Global Payroll Complexity Index 2025, India ranks 12th globally with a score of 13.4, ahead of China, Singapore, and Australia in terms of how hard it is to run a compliant payroll. That complexity shows up as six different components, each with its own rate, eligibility threshold, filing form, and deadline. If you miss any of them you may stack up penalties fast.

One Reddit user summed it up well:

That’s why in this guide, we’ll understand the fundamentals of what payroll tax actually means in India in 2026, what’s included, how each part is calculated, and what changed under the new Income Tax Act 2025. We will also cover the four Labour Codes, and how to file it all on time.

What Is Payroll Tax?

Payroll tax is the umbrella term for statutory deductions an employer withholds from an employee’s salary and remits to the government on the employee’s behalf. In India, that umbrella covers six components: TDS on salary, EPF, ESI, professional tax, labour welfare fund, and gratuity.

Globally, the term is used more narrowly. In the US, “payroll tax” specifically means the Social Security and Medicare contributions that employers and employees split fifty-fifty under FICA.

Income tax withholding is treated as a separate category there. In India, the term is used more loosely. Most HR teams, finance departments, and payroll software use “payroll tax” to mean the entire bucket of statutory deductions, including income tax collected through TDS.

That’s why “payroll tax in India” doesn’t map cleanly to “payroll tax in the US.”

Payroll Tax vs Income Tax

These two terms get used interchangeably, but they’re not the same thing. Income tax is the broader tax the government assesses on a person’s total annual income — salary, interest, capital gains, rental income, all of it. It’s calculated once a year when the employee files their ITR. Payroll tax is the mechanism for collecting a portion of that income tax (through monthly TDS) along with the other statutory contributions like PF and ESI. It happens every pay cycle, automatically, before the salary leaves the employer’s account.

In other words: income tax is the what. Payroll tax is the how. TDS on salary is the bridge between the two. It’s the slice of income tax that gets collected through the payroll machinery instead of at year-end.

What Does Payroll Tax Include in India?

In India, payroll tax includes six main components: TDS on salary, EPF, ESI, professional tax, labour welfare fund, and gratuity. Each has its own rate, eligibility threshold, and filing deadline.

Here’s what each one actually does:

TDS (Tax Deducted at Source)

TDS is the slice of income tax that gets withheld from salary every month. The employer estimates the employee’s annual tax liability, divides it across twelve months, and deducts that amount before paying out salary. It’s deposited with the Income Tax Department by the 7th of the following month.

The rate depends on the employee’s chosen tax regime and income slab. Under the new regime (the default from FY 2025-26), salaried employees pay zero income tax up to ₹12.75 lakh, thanks to the ₹75,000 standard deduction and the ₹60,000 rebate under Section 87A.

EPF (Employees’ Provident Fund)

EPF is India’s main retirement savings system. Both employer and employee contribute 12% of basic salary plus dearness allowance each month. The employee’s 12% goes entirely into the PF account. Of the employer’s 12%, 8.33% goes to the Employees’ Pension Scheme (EPS) and the remaining 3.67% goes to PF.

EPF is mandatory for organizations with 20 or more employees. In 2026, EPFO is rolling out the EPFO 3.0 framework, which will enable instant PF withdrawals via UPI and ATMs and has already raised the auto-settlement limit to ₹5 lakh.

ESI (Employee State Insurance)

ESI covers medical, maternity, and disability benefits. The employer contributes 3.25% of gross salary, the employee contributes 0.75%. It applies only to employees earning up to ₹21,000 per month (₹25,000 for persons with disabilities).

Under the Code on Social Security, 2020, (now in force from November 21, 2025) ESI coverage now extends across all of India, removing the earlier state-by-state notification requirement.

Professional Tax (PT)

Professional tax is a state-level levy capped at ₹2,500 per year. The employer deducts it from the employee’s salary and remits it to the relevant state government. Rates and slabs vary by state.

PT applies in Maharashtra, Karnataka, West Bengal, Tamil Nadu, Telangana, Andhra Pradesh, Gujarat, Odisha, Madhya Pradesh, Assam, and Kerala, among others. It does not apply in Delhi, Haryana, Uttar Pradesh, Rajasthan, or Arunachal Pradesh. Multi-state employers have to apply each state’s slab based on where the employee actually works.

Labour Welfare Fund (LWF)

LWF is a small state-level contribution that funds welfare programs for workers. It includes medical aid, housing assistance, recreation facilities, and similar. Both employer and employee contribute, but the amounts are small (typically ₹20 to ₹200 per year combined). It’s collected monthly, half-yearly, or annually depending on the state.

LWF applies in Maharashtra, Gujarat, Karnataka, Tamil Nadu, Kerala, Madhya Pradesh, and a handful of others. Not all states levy it.

Gratuity

Gratuity is a lump-sum benefit paid to an employee at exit. The employer funds it entirely and nothing is deducted from the employee’s salary. The formula is: last drawn basic + DA × years of service × 15/26.

Earlier, an employee had to complete five years of continuous service to qualify. Under the Code on Social Security, 2020, fixed-term employees now qualify after just one year. That’s a major shift for project-based and contract roles.

Who Is Eligible to Pay Payroll Tax in India?

Payroll tax in India applies to both employers and employees, with each carrying different responsibilities. Employers calculate, deduct, and remit. Employees pay their share through monthly salary deductions.

Employer Responsibilities

• Register with EPFO, ESIC, the Income Tax Department, and state-specific PT and LWF authorities
• Calculate and deduct PF, ESI, TDS, and PT from each payroll cycle
• Match the employer-side contributions (12% PF, 3.25% ESI, plus the gratuity provision)
• Remit deducted amounts to the relevant authority by their respective deadlines
• File monthly, quarterly, and annual returns
• Issue Form 130 (formerly Form 16) to employees annually

Employee Responsibilities

• Submit PAN, Aadhaar, bank account details, and investment proofs to HR at onboarding
• Choose between the old and new tax regime each financial year
• Submit Form 12BB (investment declaration) at the start of the financial year
• Verify Form 130 details and file the annual ITR
• Pay advance tax if salary income alone doesn’t fully cover the year’s tax liability (rare for purely salaried employees)

How Is Payroll Tax Calculated in India?

Calculating payroll tax in India starts with the gross salary, applies the right tax regime to determine TDS, and layers on statutory contributions for PF, ESI, and PT. Here are the FY 2025-26 slabs that drive TDS, followed by a worked example.

Income Tax Slabs for FY 2025-26 (New Regime)

The new regime is the default for FY 2025-26. Lower rates, fewer deductions.

Standard deduction of ₹75,000 for salaried employees. Rebate under Section 87A makes income up to ₹12 lakh effectively tax-free (₹12.75 lakh for salaried, after the standard deduction).

Income Tax Slabs for FY 2025-26 (Old Regime)

Available on opt-in. Higher rates, but you keep your deductions and exemptions.

Standard deduction of ₹50,000. Rebate under Section 87A makes income up to ₹5 lakh tax-free. Allows HRA, LTA, Section 80C (₹1.5 lakh), 80D (medical), 24(b) (home loan interest), and other deductions.

Sample Calculation

Let’s make this real. Say you earn ₹50,000 a month in Karnataka and you’re on the new tax regime. Here is what actually lands in your account.

Your income tax comes to zero, thanks to the Section 87A rebate. But EPF and Professional Tax still come out every month, which is where the difference between 50,000 and 46,800 comes from.

Now from your employer’s side: they are also putting in 12% EPF (₹3,000) and setting aside around ₹1,202 for your gratuity. That brings their actual cost to roughly ₹54,200 a month to employ you, even though your salary reads ₹50,000.

These numbers will shift depending on your salary structure, HRA, and other allowances. But this gives you a solid baseline to work from.

What Changed in 2026? The New Income Tax Act and Labour Codes

Two major reforms reshaped payroll tax in India in 2026: the Income Tax Act 2025 (effective April 1, 2026) and the four Labour Codes (effective November 21, 2025). Together, they replaced 29 older laws and changed how employers calculate, file, and document payroll.

The Income Tax Act 2025

The Income Tax Act 2025 replaces the six-decade-old Income Tax Act 1961. The headline tax slabs and rates carry forward unchanged, but form numbers and filing structure have been completely overhauled:

• Form 16 (annual TDS certificate) → Form 130
• Form 24Q (quarterly TDS return) → Form 138
• Form 16A (non-salary TDS certificate) → Form 131
• Form 26AS (annual tax statement) → Form 168
• Form 15G/15H → Form 121

The Act also formalizes the new tax regime as the default, locks in the ₹75,000 standard deduction, and extends the Section 87A rebate to make income up to ₹12 lakh tax-free for the salaried.

The Four Labour Codes

The four labour codes including Code on Wages, Industrial Relations Code, Code on Social Security, and the Occupational Safety, Health and Working Conditions Code, replaced 29 older labour laws from November 21, 2025. The biggest payroll implications:

• 50% basic + DA rule: Basic salary must be at least 50% of gross under the Code on Wages. This raises PF and gratuity costs for employers whose existing salary structures kept basic low.
• Gratuity at 1 year for fixed-term employees: Down from 5 years. Project-based and contract roles now qualify much faster.
• ESI coverage extended PAN-India under the Code on Social Security.
• Mandatory digital record-keeping: Physical registers no longer hold up to inspection.

Why This Matters for HR Teams

If you haven’t restructured your CTCs since November 2025, you should. The 50% basic+DA rule changes the math on every component below it. PF contributions go up. Gratuity provisions go up. The fully-loaded cost of employment rises for companies that previously kept basic salary low to manage statutory costs.

Form numbers have changed too. Payroll software needs to generate Form 130 and Form 138 instead of Form 16 and Form 24Q, and templates that still say “Form 16” won’t be valid going forward.

How to Reduce Payroll Tax and Increase Take-Home Salary in India

You cannot opt out of payroll tax, but you can legally reduce how much of your salary is exposed to it. Here are the levers that actually work.

1. Pick the right regime.

Under the new regime, income up to 12 lakh is tax-free but deductions are limited. The old regime lets you claim HRA, 80C, 80D, and home loan interest. As one Reddit user noted, “If employees were previously using deductions like HRA, Section 80C investments, or home loan interest, then the old regime may still be more tax-efficient, even if the new regime is simpler.” A rough rule: if your total deductions cross 3.75 lakh, the old regime usually wins.

2. Maximize employer contributions to NPS and EPF.

This is where most of the real savings come from under the new regime. As one Reddit user put it, “Employer’s contribution to NPS and EPF is the only way to save tax in new regime. The key word is employer. Ask your HR team to route it instead of doing it yourself. You can go up to 14% of the basic salary. On a 17 lakh CTC, that saves roughly 20,000 in taxes. In the 30% bracket, it saves 30,000. The money is locked until retirement, but as one commenter noted, “Saving for retirement on one hand and reducing tax on other. What more do you want?”

Note:

for corporate NPS subscribers, exit age is 60, not the 15-year rule that sometimes comes up online.

3. Use meal vouchers.

From April 1, 2026, the exemption has been raised to 200 per meal. That works out to up to 1,05,600 a year tax-free through cards like Pluxee or Zeta. Available under the old regime.

4. Use Section 44ADA if you’re paid by a foreign company.

According to Section 44ADA, if you work as a contractor rather than a full-time employee, you can treat only 50% of your gross receipts as taxable income. The other half is effectively tax-free. You do need to be in a notified profession and stay within the eligibility threshold, but for the right person, this is one of the more powerful levers available.

One redditor also suggests this,

5. Claim the standard deduction and marginal relief.

The 75,000 standard deduction is automatic for salaried employees under the new regime. And if your income lands just above 12 lakh, marginal relief caps your tax at the amount by which it exceeds 12 lakh. Ask your finance team to apply it.

How to File Payroll Tax in India

Payroll tax filing in India involves monthly deposits, quarterly returns, and annual certificates, filed with three authorities: the Income Tax Department, EPFO, and ESIC. Miss a deadline and interest and penalties kick in automatically.

Key Forms

• Form 138 (replaces Form 24Q): Quarterly TDS return for salary
• Form 130 (replaces Form 16): Annual TDS certificate issued to employees
• Form 12BB: Employee investment declaration, submitted at the start of the financial year
• PF ECR: Monthly EPF contribution return
• ESI Challan: Monthly ESI return
• PT Returns: Filed monthly or quarterly depending on the state

Key Deadlines

• TDS deposit: 7th of the following month
• PF and ESI deposits: 15th of the following month
• Form 138 (quarterly TDS return): 31 July, 31 October, 31 January, 31 May
• Form 130 (annual TDS certificate): 15 June for the previous financial year
• Salary disbursement: 7th of the following month under the Code on Wages

Penalties for Non-Compliance

• Late TDS deposit: 1.5% interest per month under Section 201
• Late Form 138 filing: ₹200 per day under Section 234E
• PF default: penalties up to ₹3 lakh, possible imprisonment for repeat offences
• ESI non-compliance: fines up to ₹1 lakh and prosecution

Note:

Persistent non-compliance can lead to director-level prosecution

How Payroll Tax in India Differs Globally

Payroll tax means different things in different countries. What’s included, who pays, and how much varies widely.

A few things stand out. India is the only country in this comparison where “payroll tax” includes income tax withholding. Australia treats payroll tax purely as a state-level employer cost — employees pay nothing. The US system is the cleanest of the four. India is the most layered, because every state can add its own PT and LWF slab on top of the central PF, ESI, and TDS rules.

Final Thoughts

Payroll tax in India is not a single deduction. It is a mix of central rules, state-specific rates, and compliance timelines that keep changing. The new Income Tax Act 2025 and the upcoming Labour Codes add more moving parts. For most businesses, managing this manually is a risk they cannot afford.

That is why most Indian companies end up looking at dedicated payroll software. Tools like Keka, GreytHR, Zoho Payroll, RazorpayX Payroll, Paybooks, and FactoHR are built to handle this complexity, each with different strengths around compliance, team size, and integrations.

If you are still figuring out which one fits your business, our guide to the top 10 payroll software in India breaks down the differences in detail.

The fastest way to know if a tool works for you is to test it on your own payroll data. Keka lets you do exactly that, no commitment needed.

Frequently Asked Questions

What is payroll tax in simple terms?

Payroll tax is the umbrella term for statutory deductions an employer withholds from an employee’s salary and remit to the government. In India, it covers TDS (income tax), EPF, ESI, professional tax, labour welfare fund, and gratuity. Each has its own rate, eligibility threshold, and filing deadline.

What is included in payroll taxes in India?

Payroll taxes in India include six components: TDS on salary, EPF (12% + 12% of basic+DA), ESI (3.25% + 0.75% for employees earning up to ₹21,000/month), professional tax (state-specific, max ₹2,500/year), labour welfare fund, and gratuity.

What is the purpose of payroll taxes?

Payroll taxes serve four purposes in India: collecting income tax through TDS, funding retirement savings through EPF, providing healthcare and disability coverage through ESI, and supporting state-level welfare through professional tax and LWF.

What is the payroll tax filing process in India?

Filing involves monthly TDS deposits by the 7th of the following month, monthly PF and ESI deposits by the 15th, quarterly Form 138 (formerly Form 24Q) returns, and annual Form 130 (formerly Form 16) issuance to employees by 15 June.