Still believe EPF Interest is fully tax free? Expert share it may be costing you more

Taxation of EPF: For many salaried employees, the Employees’ Provident Fund (EPF) has long been seen as a tax-friendly way to build retirement savings. Both employees and employers contribute a share of the employee’s salary into this fund, which earns interest annually. Traditionally, the entire interest earned was tax-free. But the rules changed in Budget 2021, catching many by surprise.

“People still assume all EPF interest is tax-exempt, but that’s no longer true,” warns CA Himank Singla, a chartered accountant who recently handled a case highlighting this overlooked tax trap.

Consider one of Singla’s salaried clients who came in for routine income tax return filing for FY 2024-25. At first glance, his Form 16 showed no issues—salary income, HRA, and standard deductions were all in order. But a closer look at his EPF passbook revealed a catch.

The client’s gross salary was Rs 3 lakh per month. He contributed the mandatory 12% of his basic pay to EPF, amounting to Rs 72,000 for the year. Additionally, he chose to save more through Voluntary Provident Fund (VPF), contributing Rs 3.28 lakh extra.

This brought his total EPF+VPF contribution to Rs 4 lakh for the year—well above the tax-free ceiling introduced by the 2021 amendment.

Here’s the critical rule change:

From FY 2021-22 onwards, interest earned on employee contributions exceeding Rs 2.5 lakh per year is taxable under “Income from Other Sources.”

For government employees with no employer contribution, the threshold is higher at Rs 5 lakh.

In Singla’s client’s case, Rs 1.5 lakh of the contribution exceeded the Rs 2.5 lakh threshold. With an EPF interest rate of approximately 8.25%, this generated around Rs 12,375 in interest, which became taxable.

“And it’s not just taxable,” Singla added. “It’s also subject to TDS if thresholds are crossed and must be reported in your ITR under ‘Income from Other Sources.’ People think it’s safe in the EPF account, but that doesn’t exempt it from tax.”

Importantly, this limit applies only to employee contributions. Employer contributions have their own combined ceiling of Rs 7.5 lakh annually under Section 17(2)(vii), covering employer payments into EPF, NPS, and Superannuation Funds. Interest earned on any excess contributions is taxable under a separate provision.

The takeaway for all salaried employees is clear:

Track your combined EPF and VPF contributions.

Keep annual employee contributions under Rs 2.5 lakh if you want tax-free interest.

Understand that EPFO now maintains separate taxable and non-taxable accounts.

EPF remains one of India’s safest retirement tools. But post-2021, its tax-free status comes with strings attached. For those maximizing VPF contributions, careful tax planning is now essential to avoid unexpected tax liabilities. 
However, the PF amount withdrawn at retirement is tax-free, provided the employee has made continuous contributions to the EPF account for at least five consecutive years.