Gratuity is a lump sum your employer pays for long service, and part or all of it is exempt from tax under Section 10(10). For a covered private-sector employee, the exempt amount is the least of ₹20 lakh, the actual gratuity received, or 15 days' pay for each completed year of service. Gratuity paid to a government employee is fully exempt.
The ₹20 lakh figure gets quoted as if it were the tax-free amount. It is only the ceiling. For most people the exemption is capped lower, by the formula or by the actual cheque, whichever is smallest.
Gratuity exemption at a glance
What is gratuity, and when is it taxed?
Gratuity is a one-time payment an employer makes for continuous service, usually payable after five years, on retirement, resignation, death, or disablement. For most establishments it is governed by the Payment of Gratuity Act, 1972.
The money is not tax-free by default. Section 10(10) of the Income-tax Act decides how much escapes tax, and the rest is taxed as salary income at your slab rate. Gratuity paid while you are still in service, rather than on exit, is fully taxable.
How much gratuity is tax-free?
For a private-sector employee covered by the Payment of Gratuity Act, the exempt amount is the least of three figures:
- ₹20 lakh – the ceiling notified by the government;
- the actual gratuity received; and
- 15 days' salary for each completed year of service, worked out as (last drawn monthly salary × 15 × years of service) ÷ 26.
"Salary" here means basic pay plus dearness allowance. Whichever of the three is smallest is the tax-free portion, and anything above it is taxable. The ₹20 lakh is a lifetime limit across all employers, not a fresh allowance at each job.
How is the 15-days-per-year formula calculated?
The divisor of 26 assumes 26 working days in a month, so "15 days' pay" is a little over half a month's salary for each year. Suppose someone retires after 20 years with a last-drawn basic-plus-DA of ₹60,000 a month and receives ₹8 lakh of gratuity (illustrative figures).
The formula gives (₹60,000 × 15 × 20) ÷ 26, which is about ₹6.92 lakh. The three figures are ₹20 lakh, ₹8 lakh actually received, and ₹6.92 lakh from the formula. The least is ₹6.92 lakh, so that much is tax-free and the remaining ₹1.08 lakh is taxed as salary. A part-year over six months counts as a full year in the service count.
Is gratuity for government employees taxed differently?
Yes. Gratuity received by central, state, or local government employees is fully exempt from tax, with no monetary ceiling. The ₹20 lakh cap and the least-of-three test apply to private-sector employees.
Employees of private firms not covered by the Payment of Gratuity Act follow a slightly different formula – roughly half a month's average salary for each completed year – but the ₹20 lakh ceiling and the actual-amount limit still apply. The broad shape is the same: the smallest of the ceiling, the formula, and the amount paid.
Is gratuity paid on resignation, or only on retirement?
Gratuity is not limited to retirement. Under the Act it is payable on retirement, resignation, superannuation, death, or disablement – as long as the five-year service condition is met. So an employee who resigns after five years or more is entitled to it, and the same Section 10(10) exemption applies to that payout.
The five-year floor is the usual sticking point. Leave before completing five continuous years and, in most cases, no gratuity is due at all – there is nothing to exempt. The exception is exit due to death or disablement, where the five-year rule is waived and gratuity is paid regardless of tenure.
What happens to gratuity above the exempt limit?
Anything beyond the exempt portion is added to your salary income for the year and taxed at your slab rate. Because the ₹20 lakh ceiling is a lifetime figure, gratuity you have already claimed as exempt at an earlier job reduces what is left for a later one.
One point worth knowing: the Section 10(10) exemption applies under both the old and the new tax regime. It is not one of the deductions the new regime strips away, so the tax-free treatment survives whichever regime you are on.
Related NYVO guides
- Income Tax Slabs in India – the slab rates that apply to any gratuity above the exempt portion.
- Goal-Based Planning 101: Turning Life Into Numbers – how a retirement lump sum fits into longer-term goals.
- Saving vs Investing: Which Comes First? – a starting frame for deploying a large one-time payout.
A gratuity cheque feels like a reward for years of work, and part of it usually is tax-free. Knowing which of the three limits binds in your case tells you, before the money arrives, how much of it the tax return will actually let you keep.
