Draft Income Tax Rules 2026 Unveiled: Key Changes for Salaried and Middle-Class Taxpayers
The Income Tax Department has officially released the Draft Income Tax Rules 2026, setting the stage for significant reforms that will impact taxpayers starting from the financial year 2026-27. These draft rules, once approved, introduce several modifications aimed at simplifying tax structures and providing relief to salaried individuals and the middle class, with implications for taxable income and overall tax liability.
Overview of the Draft Rules and Public Consultation
The draft rules correspond to the new Income Tax Act 2025, scheduled for implementation from April 1, 2026. They are currently open for public suggestions until February 22, 2026, after which the government will finalize and notify the rules. According to Kuldip Kumar, Partner at Mainstay Tax Advisors, the draft reflects a streamlined approach with simplified language, improved structure, and the removal of redundant provisions, making it easier for taxpayers to understand and reference. "While introducing these changes, the government has also kept relevance and practicality in view," Kumar stated in an interview with TOI.
Major Changes in Exemptions and Allowances
The draft rules propose substantial updates to exemption limits and coverage areas, particularly for house rent allowance (HRA), children education allowance, and hostel allowance, which had remained unchanged for decades.
HRA Benefits: Expansion to More Cities
In a significant relief for taxpayers in major urban centers, the draft Income Tax Rules 2026 propose to include Ahmedabad, Pune, Bengaluru, and Hyderabad in the 50% HRA exemption category. Currently, this benefit is limited to metro cities like Delhi, Mumbai, Chennai, and Kolkata. Under the new proposal, employees in these additional cities will be able to claim a higher tax-free HRA, as the exemption calculation shifts from 40% to 50% of salary for non-metro areas.
Shalini Jain, Tax Partner at EY India, explained that while the formula for calculating HRA exemption remains unchanged, the draft rules aim to increase the number of cities where 50% of salary is considered. "Cities such as Hyderabad, Pune, Ahmedabad, and Bengaluru are proposed to be added to the list, taking into account growing population and job opportunities," she noted. Richa Sawhney, Partner at Grant Thornton Bharat, added that this move acknowledges the sharp rise in rental costs in these cities, providing meaningful relief to taxpayers.
Education and Hostel Allowance Hikes
The draft rules also propose significant increases in allowances for children's education and hostel expenses. The education allowance limit is set to rise from Rs 100 per month per child to Rs 3,000 per month per child, while the hostel allowance limit will increase from Rs 300 per month per child to Rs 9,000 per month per child. These exemptions are available for a maximum of two children per taxpayer.
Shalini Jain emphasized that these revisions are much needed due to the exponential increase in education and hostel costs over the years. However, she pointed out that these benefits are only accessible if taxpayers opt for the old tax regime.
Tax Savings Example: Up to Rs 1.41 Lakh Benefit
An analysis by ClearTax, conducted for TOI, illustrates the potential tax savings under the new rules. For an individual earning Rs 35 lakh annually, living in a rented home in Bengaluru with two children in a hostel, the tax benefit under the old regime could be substantial.
Archit Gupta, Founder and CEO of ClearTax, detailed the savings:
- HRA Upgrade: With Bengaluru moving to a 50% exemption, the HRA deduction limit increases, reducing taxable income by Rs 1.75 lakh.
- Education and Hostel Allowances: The new limits allow for an additional Rs 2.78 lakh to be removed from taxable income, compared to the old rules.
Combined, these changes lower total taxable income by approximately Rs 4.5 lakh, resulting in a net tax saving of Rs 1,41,461. "For an individual earning Rs 35 lakh, saving over Rs 1.41 lakh isn't just a deduction on paper; it is real money back in the pocket. This is a pro-middle-class correction that finally helps balance income against the rising cost of living," Gupta stated.
Other Key Changes in the Draft Rules
The draft Income Tax Rules 2026 include several other important updates:
Revised Perquisite Valuation for Employer-Provided Cars
Kuldip Kumar highlighted that the increase in valuation for employer-provided cars used for both official and personal purposes will adversely affect mid-level and above employees. The annual additional tax impact could range from approximately Rs 19,843 to Rs 31,356 for those in the 30% tax bracket, depending on car engine capacity and income levels.
Mandatory PAN Card Quoting Limits
The draft rules propose changes to transaction limits requiring PAN card quoting. For instance, PAN will be mandatory for cash deposits exceeding Rs 10 lakh in a financial year, up from the current Rs 50,000 per day limit. Similarly, cash withdrawals over Rs 10 lakh in a financial year from banks or post offices will require PAN.
Additional Updates
- Loans from Employer: The threshold for interest-free or concessional loans not attracting perquisite tax is proposed to increase from Rs 20,000 to Rs 2,00,000.
- Gifts and Vouchers: The tax-free limit for gifts/vouchers may rise from Rs 5,000 to Rs 15,000 per year.
- Meal Coupons: The limit per meal could be enhanced from Rs 50 to Rs 200.
- Foreign Tax Credit: Form 67 is replaced by Form 44, with verification by an accountant required for foreign taxes paid of Rs 1,00,000 or more.
Kuldip Kumar suggested that the government consider an automated mechanism to periodically revise these limits by linking them to the Cost Inflation Index, preserving the real value of benefits year on year.
Choosing Between New and Old Tax Regimes
It is crucial for taxpayers to note that the benefits of enhanced HRA exemptions and increased allowances are only available under the old income tax regime. Therefore, individuals must carefully evaluate their tax positions to decide which regime is more beneficial. Shalini Jain of EY India advised that salaried taxpayers will need to compare the tax impact based on individual circumstances, as those opting for the new regime will not avail these enhanced limits.
Richa Sawhney of Grant Thornton Bharat added that the enhanced thresholds are more in tune with current financial realities, factoring in rising costs of living. She recommended that taxpayers reassess their positions under both regimes to make informed decisions.
In summary, the Draft Income Tax Rules 2026 propose transformative changes aimed at providing relief to salaried and middle-class taxpayers, with a focus on updated exemptions and simplified compliance. As the public consultation period progresses, these rules are poised to reshape tax planning strategies for the upcoming financial year.
