Introduction
Gratuity is a significant component of an employee’s retirement benefits in India. While it provides financial security, many salaried individuals are unaware of how gratuity is taxed and the exemptions available under Section 10(10) of the Income Tax Act.
In this article, we’ll cover:
What is gratuity and who is eligible?
How gratuity is calculated?
Tax exemptions on gratuity under Section 10(10).
How to minimize tax liability on gratuity payouts.
1. What is Gratuity?
Gratuity is a lump sum payment made by an employer to an employee as a reward for long-term service. It is governed by the Payment of Gratuity Act, 1972 and is applicable to employees who have completed at least 5 years of continuous service with the same employer.
Who is Eligible for Gratuity?
Employees working in companies with 10 or more employees.
Must have completed at least 5 years of continuous service (except in case of death or disability).
Applies to salaried employees in private and government sectors.
Did You Know? Even if an employer is not covered under the Gratuity Act, they can still offer gratuity as part of an employee’s compensation.
2. How is Gratuity Calculated?
Gratuity is calculated using the following formula:
For Employees Covered Under the Gratuity Act:Gratuity=Last Drawn Salary×15×No. of Years of Service26\text{Gratuity} = \frac{\text{Last Drawn Salary} \times 15 \times \text{No. of Years of Service}}{26}Gratuity=26Last Drawn Salary×15×No. of Years of Service
Last Drawn Salary includes Basic Salary + Dearness Allowance (DA).
15 days of salary is considered for each completed year of service.
Example Calculation:
If an employee’s last drawn salary (Basic + DA) is ₹50,000 and they have worked for 10 years, gratuity will be:50,000×15×1026=₹2,88,462\frac{50,000 \times 15 \times 10}{26} = ₹2,88,4622650,000×15×10=₹2,88,462
For Employees Not Covered Under the Gratuity Act:Gratuity=Last Drawn Salary×15×No. of Years of Service30\text{Gratuity} = \frac{\text{Last Drawn Salary} \times 15 \times \text{No. of Years of Service}}{30}Gratuity=30Last Drawn Salary×15×No. of Years of Service
The formula remains the same, but 30 days is considered instead of 26.
Tip: Employers may offer higher gratuity amounts voluntarily, but only the statutory limit is exempt from tax.
3. Tax Exemption on Gratuity Under Section 10(10) of the Income Tax Act
The taxation of gratuity depends on the type of employer:
A. Government Employees
Fully exempt from tax under Section 10(10)(i).
No tax on gratuity received on retirement, resignation, or death.
B. Private Sector Employees Covered Under the Gratuity Act
Exempt up to the lower of the following three:
- ₹20 lakh (as per the latest amendment in 2019).
- Actual gratuity received.
- 15 days’ salary × No. of years of service (calculated using the formula).
Example:
If an employee receives ₹18 lakh as gratuity, it is fully exempt. However, if they receive ₹22 lakh, then only ₹20 lakh is exempt, and ₹2 lakh will be taxable as per their income tax slab.
C. Private Sector Employees Not Covered Under the Gratuity Act
Exempt up to the lower of the following three:
- ₹20 lakh.
- Actual gratuity received.
- Half a month’s average salary × No. of completed years of service.
Key Update: In 2019, the tax-free gratuity limit was increased from ₹10 lakh to ₹20 lakh for private-sector employees.
4. How to Minimize Tax on Gratuity?
Use the ₹20 lakh exemption limit effectively – If you receive gratuity in multiple phases from different employers, check whether you have exceeded the total exemption limit.
Plan voluntary retirement smartly – If you are close to retirement and expect a large gratuity payout, check if splitting the amount between financial years helps reduce tax liability.
Opt for structured salary components – If your employer allows, you may request a higher share in provident fund (PF) or NPS contributions to optimize post-retirement tax planning.
Invest gratuity wisely – Invest in tax-efficient options like National Pension System (NPS), tax-free bonds, or PPF to continue benefiting from tax exemptions.
5. Gratuity Payment Rules for Employees Changing Jobs
- If you switch jobs after 5+ years, gratuity can be transferred to the new employer if they agree.
- If the new employer does not transfer gratuity, you can withdraw it tax-free (up to ₹20 lakh).
- If you have less than 5 years of service, you may not be eligible for gratuity unless due to death or disability.
Tip: Keep track of gratuity payments from multiple employers, as the total lifetime tax-free limit remains ₹20 lakh.
6. How to Claim Gratuity?
Steps to Claim Gratuity from Your Employer:
Submit Form I to your employer within 30 days of retirement/resignation.
Employer verifies the claim and processes the amount within 30 days.
If delayed, the employer is liable to pay interest on the gratuity amount.
Where to File a Complaint for Gratuity Non-Payment?
If your employer refuses to pay gratuity, file a complaint with:
- The Labour Commissioner in your region.
- Central Industrial Relations Officer (CIR) for government employees.
Government Reference: Ministry of Labour & Employment – Gratuity Rules
Conclusion
Gratuity is an important financial benefit that provides long-term stability for salaried employees. However, understanding how it is calculated, the tax implications, and exemption limits is key to maximizing your benefits.
Government employees enjoy 100% tax exemption on gratuity.
Private sector employees can claim up to ₹20 lakh tax-free gratuity under Section 10(10).
Gratuity is taxable if it exceeds the exemption limit, so plan withdrawals wisely.
If gratuity is not received, employees have legal rights to claim it.
Tip: If you are expecting a large gratuity payout, consult a tax advisor to structure your finances for optimal tax savings!
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How to Save Income Tax for Salaried Employees – Beyond Section 80C, HRA, and Housing Loan Benefits
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Useful Government & External References
Ministry of Labour & Employment – Payment of Gratuity Act
Income Tax Department – Gratuity Taxation Rules
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