Does Gratuity Fall Under Taxable Income Under The Income Tax Act?

Gratuity is a benefit given in a lump sum amount, as a recognition by the employer to an employee for his loyalty and continuous service for 5 years and more at the time of retirement, resignation, superannuation, death or disability. In case of an employee’s death, gratuity is paid for the number of years he has worked for the company, irrespective of the tenure with the company. The nominee receives the gratuity on behalf of the deceased employee. 

An individual employed in any public or private sector organization with 10 or more employees or working in a factory, port or plantation is eligible to receive a gratuity for his continuous service. Under income tax laws, gratuity is tax-exempt up to a limit of 20 lakhs. Let us first understand how gratuity is calculated.

Calculation of Gratuity

Gratuity is governed by the Payment of Gratuity Act, 1972 and is applicable to permanent employees only. Gratuity is calculated based on salary and the number of years of service of an employee. It is calculated differently for different categories. If you are –

  • Covered under the Payment of Gratuity Act:

As per the gratuity act, an employee should get a gratuity equal to 15 days’ salary for every year of service. The gratuity you receive is calculated as;

Gratuity = salary*number of years of service *15/26

Where,

Salary = Basic pay + DA

15 = number of days in a month for which salary is considered

26 = working days in a month.

Consider an example, if you work with a company for a period of 20 years, and your salary is Rs. 50,000. The amount you will receive is 

Gratuity = 50,000*20*15/26 = Rs. 5,76,923.

  • Not covered under the Payment of Gratuity Act:

Gratuity = ½*(last 10 months’ salary)/10 * number of years of service.

Where,

Salary is the average salary for the last 10 months

The number of years of service is rounded off, and the fraction part is ignored.

If you want to calculate your gratuity amount, use a gratuity calculator. It is an online tool which calculates the gratuity amount based on the above formula. It is a useful and simple tool that gives you an estimate in seconds. You just have to enter your salary and number of years of service, and it will calculate the amount. You can even recalculate by changing inputs.

Taxation Rules for Gratuity

The amount received as gratuity is considered as income under the head ‘salaries’. In case of death, it is received by the nominee and treated under ‘Income from other sources. An employee is therefore mandatorily required to provide the name of a nominee as per the Payment of Gratuity Act.  

If gratuity is received during the service, it is fully taxable under the Income Tax Act, 1961. If received in case of retirement, resignation or death, tax exemption is applicable under section 10(10) of the Income Tax Act.

Tax Exemption on Gratuity

The tax exemption on gratuity is applicable under section 10(10) of the Income Tax Act as follows:

  • Gratuity received by a government employee (central/state/local authority), defense personnel is entirely tax exempt.
  • Gratuity received by an employee in a private sector company, which is covered under the Payment of Gratuity Act, will be tax exempt up to the least of the following
  1. Rs. 20 lakhs
  2. Actual gratuity amount received.
  3. The eligible amount of gratuity calculated as salary*number of years of service *15/26
  • Gratuity received by an employee in a private sector company, which is not covered under the Payment of Gratuity Act, will be tax exempt up to the least of the following
  1. Rs. 10 Lakhs
  2. Actual gratuity received by the employee
  3. Last 10 months average salary*years of service*½

Note that the amount beyond the maximum limit is taxable as per the law. If you want to calculate the tax liability on the gratuity amount you received, use a gratuity tax calculator available on the website of the Income tax department in the same way you use an income tax calculator.

Conclusion

This was all about the taxability and exemptions of the gratuity you receive. Also, remember that gratuity has to be paid within 30 days of the receipt of the application. If not paid within the deadline, simple interest is to be paid from the date of eligibility. As it is a substantial amount, use it wisely.