Gratuity is a lump-sum benefit paid by an employer to an employee who has completed at least 5 years of continuous service, whether they resign, retire, or are otherwise separated from the company (the 5-year requirement is waived in cases of death or disability). Unlike many salary components, gratuity carries a genuinely generous tax exemption, and understanding exactly how much is exempt helps you plan around it rather than being surprised at tax filing time.
How Gratuity Is Calculated
For employees covered under the Payment of Gratuity Act (which applies to most establishments with 10 or more employees), the formula is:
Gratuity = (Last Drawn Salary × 15 × Years of Service) ÷ 26
Here, "last drawn salary" means basic pay plus dearness allowance, and 26 represents the working days in a month under the Act's calculation convention. Years of service is rounded to the nearest full year for this formula, with a period of 6 months or more counted as a full year.
Example: if your last drawn basic plus DA is ₹60,000 and you've completed 12 years of service, your gratuity works out to (₹60,000 × 15 × 12) ÷ 26 = ₹4,15,385.
The Tax Exemption Limit
For private-sector employees covered under the Payment of Gratuity Act, the tax exemption is up to ₹20 lakh. For government employees (central, state, and local authority), the entire gratuity received is exempt, without the ₹20 lakh cap.
This ₹20 lakh limit is a lifetime aggregate limit across all employers, not a per-employer or per-instance limit. If you've already received and claimed exemption on gratuity from a previous job, that amount counts against your lifetime ₹20 lakh limit when you receive gratuity again from a later employer.
What Happens If Your Gratuity Exceeds ₹20 Lakh
The exemption applies to the least of three amounts: the actual gratuity received, the amount calculated under the formula above, or ₹20 lakh. Whatever exceeds ₹20 lakh (after considering any exemption already claimed against your lifetime limit) is added to your taxable income for the year and taxed at your applicable slab rate. For most employees, gratuity payouts fall well within ₹20 lakh, so this becomes relevant mainly for very senior employees with long tenure and high salaries.
Is Gratuity Exemption Available Under Both Tax Regimes?
Yes, unlike HRA, 80C, and several other salary exemptions that disappear under the new tax regime, gratuity exemption under Section 10(10) is retained under both the old and new tax regimes. This is one of the few salary-related exemptions that survives the switch, worth factoring in if you're comparing the two regimes and have a gratuity payout expected soon.
What If You're Not Covered Under the Payment of Gratuity Act?
Some smaller establishments or specific employment arrangements aren't covered under the Act. Employees not covered use a slightly different formula (based on half a month's average salary for the last 10 months, multiplied by years of service) and the exemption limit still applies, subject to the same ₹20 lakh overall cap, though the calculation itself differs from the standard formula above.
Planning Around a Gratuity Payout
If you're approaching retirement or planning to resign after a long tenure, it's worth calculating your expected gratuity in advance, both to understand your take-home amount and to check whether it falls within your remaining lifetime exemption limit, especially if you've already claimed exemption on gratuity from an earlier job. Our gratuity calculator works out your expected payout based on your salary and years of service.
Frequently Asked Questions
Do I need to complete exactly 5 years to be eligible for gratuity?
Generally yes, 5 years of continuous service is the standard requirement, with some employers and court interpretations treating service just short of 5 years (like 4 years and 240 days) as qualifying in specific circumstances. This requirement is waived entirely in case of death or disability, regardless of tenure.
Is gratuity paid even if I resign, or only on retirement?
Gratuity is payable on resignation too, provided you've completed the minimum qualifying service period, it isn't limited to retirement, layoff, or termination.
Does gratuity received on death of an employee follow the same tax exemption rules?
Gratuity received by nominees or legal heirs on the death of an employee is fully exempt from tax, regardless of the ₹20 lakh limit that applies to gratuity received by the employee themselves.
How do I know if my previous employer already used up part of my lifetime exemption limit?
Check your tax records and Form 16 or ITR from the year you received gratuity previously, the exempt amount claimed at that time reduces your remaining lifetime limit for any future gratuity received from subsequent employers.
