TDS Shortfall on Salary: When the Employer Is Liable and What an Employee Must Watch For

TL;DR

• TDS shortfall happens when the employer deducts less than the required tax based on your projected income and chosen regime.
• Section 201(1) treats the employer as an assessee-in-default for both the deficit and interest under Section 201(1A) at 1% per month.
• Section 271C can lead to penalty equal to the unpaid TDS, and Section 276B can even trigger prosecution.
• Section 205 protects employees from being asked to pay tax that was supposed to be deducted by the employer.
• Practical reality: even if the employer is technically liable, you still need to pay your final tax liability as self-assessment if it remains unpaid.

What this means in plain terms

The TDS system is built on the assumption that the employer estimates your tax correctly and deducts the right amount each month. When that estimate is wrong by a small margin, it is fine. The reconciliation in March or at the time of ITR filing settles things. But when the shortfall is large — because the employer missed reporting other income, did not increase TDS after a bonus, or simply made a calculation error — the law has clear consequences.

Section 201 makes the employer liable for the unpaid tax along with interest. Section 205 protects you, as the employee, from being directly chased by the department for the same amount. That sounds reassuring, but in practice the employee still has to be careful. If you owe additional tax at filing time and the TDS deducted is less than what you actually owe, you cannot wave Section 205 and walk away. You must pay self-assessment tax and seek redress later if the employer was at fault.

Why TDS shortfall happens

Underestimated salary

Employers usually finalise the TDS calculation at the start of the year based on projected salary. If you receive a significant bonus, retention payout, or stock perquisite later that was not factored in, the cumulative TDS deducted may fall short.

Over-claimed deductions

You may have declared 80C investments of Rs. 1,50,000 in April but actually made only Rs. 80,000 by March. Your employer's TDS was based on the full declaration. The shortfall arises in the final months when the lower actual investment is recognised.

Regime mismatch

You declared the new regime to your employer but discover at filing time that the old regime is better with HRA, home loan interest, and 80C. The good case is when this leads to a refund. The bad case is when the new regime actually had a lower tax in your situation and the old regime triggers a higher liability than what was deducted.

Other income beyond salary

If you have rental income, capital gains, dividends, or interest income that you did not declare to your employer, none of this is captured in salary TDS. Banks deduct some TDS on FD interest but not on dividends or capital gains. The aggregate tax liability can exceed your total TDS.

Section 201 consequences for the employer

Assessee-in-default

Under Section 201(1), if an employer fails to deduct the correct TDS, fails to deposit it, or both, they are treated as an assessee-in-default for the shortfall. The department can recover the unpaid amount from the employer through demand.

Interest under Section 201(1A)

Section 201(1A) attracts interest at 1% per month from the date TDS was deductible to the date it is actually deducted, plus 1.5% per month from the date of deduction to the date of deposit. This adds up quickly when shortfalls drag on for months.

Penalty under Section 271C

If the failure to deduct TDS is held to be without reasonable cause, the employer can be hit with a penalty equal to the unpaid TDS under Section 271C. This is in addition to interest and not in lieu of it.

Prosecution under Section 276B

In serious cases of deliberate non-deduction or non-deposit, Section 276B allows criminal prosecution with rigorous imprisonment between three months and seven years. This is rare but not unheard of for repeated defaulters.

Section 205 protection for employees

What Section 205 says

Section 205 provides that where tax is deductible at source under the relevant provisions, the assessee shall not be called upon to pay the tax himself to the extent to which tax has been deducted from the relevant income. In plain language, if the employer was supposed to deduct, you cannot be asked to pay it again.

How it plays out in practice

Section 205 protects you from a department demand for amounts that should have been deducted by the employer but were not deposited. If your Form 16 shows TDS deducted but Form 26AS shows nothing, the department cannot ask you to pay because the employer failed to deposit.

Limits of Section 205

Section 205 does not absolve you from paying the underlying tax liability at the time of filing your return. If your final tax computation shows tax payable, you must pay it as self-assessment tax. Section 205 only stops the department from raising a separate demand on you for what the employer should have deducted but did not.

Recourse against employer

If your employer deducted TDS from your salary but did not deposit it, you have the right to take this up with the Labour Commissioner, the EPFO, or file a complaint with the income tax department. The department typically begins recovery action against the employer.

A real example

Pooja, 36, Rs. 16L CTC, Gurugram, works at a mid-size consulting firm. Her employer projected her annual salary as Rs. 16,00,000 and deducted TDS accordingly. In October 2025, she gets a Rs. 4,00,000 retention bonus, taking her total income to Rs. 20,00,000. Her employer fails to update the TDS calculation, and the deducted TDS for the year remains based on Rs. 16,00,000.

Here is what unfolds:

1. Form 16 shows total TDS of Rs. 2,40,000 against actual liability of Rs. 3,50,000.
2. Pooja files her ITR honestly, declaring all income. The portal shows tax payable of Rs. 1,10,000 as self-assessment tax.
3. She pays the Rs. 1,10,000 along with interest under Sections 234B and 234C of about Rs. 8,000.
4. She raises a formal grievance with her HR pointing out that the bonus was not factored into TDS, and requests them to reimburse the additional interest.
5. The employer realises the lapse, deposits the missed TDS for future quarters, but the Section 201 interest of 1% per month on the unpaid TDS for the months it was due falls on them.
6. The department typically does not pursue Pooja for the Rs. 1,10,000 because she paid as self-assessment, but the employer faces Section 201 interest of approximately Rs. 5,000-10,000.

What to do this week

1. Pull your latest payslips and verify whether the year-to-date TDS deducted matches what you would expect at your projected slab rate.
2. Check Form 16 (for prior year) and Form 26AS (for current year-to-date) to confirm employer's TDS deposits are timely.
3. If you received a bonus or other income that was not factored into salary TDS, ask HR to recalculate the remaining months.
4. Pay any anticipated shortfall as advance tax under Section 211 by 15 December and 15 March to avoid Section 234B and 234C interest.
5. Run the 6-step assessment at https://myfinancial.in to see your old-vs-new regime delta, unused deductions, and insurance gap in under 10 minutes.

FAQ

What if my employer deducted TDS but did not deposit it?

Section 205 protects you. The department cannot ask you to pay the same tax again. You should raise a grievance with the assessing officer and provide your Form 16 and salary slips as evidence. The department then pursues the employer.

Can I be penalised if there is a TDS shortfall?

No, not directly. Penalties under Section 271C and prosecution under Section 276B apply to the deductor (the employer), not to you. Your only obligation is to pay your final tax liability through self-assessment.

Does Section 234B apply if the shortfall was the employer's fault?

This is a grey area. Section 234B applies when advance tax paid is less than 90% of assessed tax. Courts have held in some cases that interest is not chargeable on the portion attributable to employer's failure. Consult a CFP and litigate if needed.

How do I report employer's TDS failure?

You can submit a written complaint to the jurisdictional Assessing Officer with copies of your Form 16, payslips, and bank statements. The department initiates an inquiry under Section 201. You can also use the e-Nivaran portal on incometax.gov.in.

What if my Form 16 amount and Form 26AS amount differ?

You can claim the Form 16 amount as TDS in your ITR even if Form 26AS shows less, by attaching evidence of deduction. However, expect a Section 143(1) intimation, and you may need to pursue rectification.

Can I refuse to pay self-assessment tax citing employer's failure?

No. Even though Section 205 protects you from the department's demand for what should have been TDS, the underlying tax liability is yours. You must pay self-assessment tax. Section 205 is a protection against double recovery, not an exemption from your liability.

How does the new tax regime affect TDS shortfall risk?

Lower potential for shortfall because the new regime has fewer deductions to track. But the risk shifts — employees who unwittingly declared new regime to their employer and have substantial 80C, HRA, and home loan benefits may end up with a refund situation, not a shortfall.

Sources

• Income Tax Department, Section 201 and Section 205: https://incometax.gov.in/
• TRACES, TDS related grievances: https://www.tdscpc.gov.in/
• e-Nivaran portal for tax grievances: https://incometax.gov.in/
• CBDT circulars on Section 201: https://incometax.gov.in/iec/foportal/

This is general information, not personalised advice. For your situation, consult a Certified Financial Planner.