How will EPF above Rs 2.5 lakh be taxed? With 2 EPF accounts!

Yes, you read that right. You will now have 2 EPF accounts. In a way atleast.

It was earlier announced in Budget 2021, that in a given financial year, the government came up with the new EPF 2.5 lakh rule or PF 2.5 lakh rule because of which, the interest on EPF contributions above Rs 2.5 lakh will be taxed. Now the rules for taxation of this interest on the excess EPF contributions (above Rs 2.5 lakh) are made available by the government here.

Here are few important points to explain how it will be taxed:

  • All contributions made till 31st March 2021 will be considered as non-taxable contributions.
  • Going forward from FY2021-22, i.e. from 1st April 2021, two (2) separate accounts within the EPF shall be maintained. One account will be for contributions up to Rs 2.5 lakh. This will be the account for Non-Taxable Contribution. The other account will have contributions above Rs 2.5 lakh every year, which will come under the taxable contributions.
  • From FY2021-22 onwards (after 1st April 2021), the interest will be separately calculated on both these EPF accounts.
  • Do note that this segregation and maintenance of 2 separate accounts are only for the purpose of calculation of the taxable interest. This doesn’t mean that you will now actually have 2 EPF accounts. Your EPF UAN will remain the same as before.

Let me explain it with an example.

Suppose that on 31 Mar – 1 Apr 2021, your EPF balance (including interest accrued till date was Rs 10 lakh. Now your monthly EPF contribution is Rs 30,000, i.e. Rs 3.6 lakh per year.

This is above the Rs 2.5 lakh limit. Hence, the interest earned on contributions up to Rs 2.5 lakh will be tax-free, but the interest on amounts above Rs 2.5 lakh, i.e. Rs 1.1 lakh will be taxable. On this amount, the interest earned will be taxed as per your income tax slab.

So with 2 EPF accounts now, this is how it will work:

  • EPF Account 1 (Non-Taxable Contribution) = Rs 10 lakh + Rs 2.5 lakh
  • EPF Account 2 (Taxable Contribution) = Rs 1.1 lakh

Though Rs 2.5 lakh Rule is not applicable to PPF, those who also make additional contributions via VPF, will come under similar EPF tax implementation.

Suppose your EPF account balance at the end of FY2020-21 was Rs 25 lakh. Now your EPF Contribution is Rs 20,000 per month. But you also make additional Rs 40,000 contribution towards VPF every month. So in total, your contribution is Rs 60,000 per month or Rs 7.2 lakh per year. Dividing it between the new concept of 2 EPF accounts for taxation purposes:

  • EPF Account 1 (Non-Taxable Contribution) = Rs 25 lakh + Rs 2.5 lakh
  • EPF Account 2 (Taxable Contribution) = Rs 4.7 lakh (= Rs 7.2 lakh contribution – Rs 2.5 lakh tax-free contribution).

So how will taxation actually happen for the second taxable EPF account?

Let’s continue with the previous example.

Now this amount of Rs 4.7 lakh in EPF Account 2 (Taxable Contribution) will generate interest. Let’s say you generate a total of Rs 35,000 interest on this amount (check the latest EPF interest rate history). Since you have to pay the tax on this as per your tax slab, let’ say you belong to the 30% tax slab. So you will pay 30% of Rs 35,000, i.e. Rs 10,500 as a tax on this.

The TDS aspect of this is still not clear. I remember it was earlier mentioned that excess EPF contribution above Rs 2.5 lakh will be taxed in a manner similar to how fixed deposits are taxed. Now banks deduct TDS on FD interest. I am not sure if PF authorities will deduct any TDS themselves or the liability remains completely with the employee.

Further Reading – Should you still invest more than Rs 2.5 lakh in EPF?

In general, this is how your EPF account will get divided into 2 parts and taxed going forward:

  • EPF Account 1 (Non-Taxable Contribution) – This will include the EPF account balance (including interest accrued but not paid) till 31st March 2021. Plus all your EPF + VPF contributions made during the FY up to Rs 2.5 lakh only. It will also continue to accrue and add the interest generated from your contributions (up to Rs 2.5 lakh) and all your Employer’s contributions.
  • EPF Account 2 (Taxable Contribution) – This will include only the amount of contribution above Rs 2.5 lakh a year by the employee from FY 2021-22 onwards. Plus, it will also include the interest earned on this contribution about the threshold of Rs 2.5 lakh.

So as now the government has notified the rules for taxation of interest on excess PF contribution, you have seen above how the interest on excess PF contribution above Rs 2.5 lakh will be taxed as per the new PF rules in India (2021 and going forward).

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