The nature of the allowance determines if it is taxable or not. Allowances like Hostel Expenditure Allowance, Children Education Allowance, Leave Travel Allowance and House Rent Allowance, which are often part of the salary are partially tax-exempt. On the flipside, allowances such as City Compensatory Allowance, Special Allowance, and Overtime Allowance are taxable in the hands of the employee.