Gratuity — Eligibility, Calculation, and How It's Taxed
Gratuity is money you're owed after 5 years — but most don't know the formula, the tax treatment, or what happens if they leave just short of qualifying.
Priya has worked at the same company for 4 years and 10 months. She has a better offer. She resigns.
Two months later, her friend Karan resigns from the same company — after exactly 5 years and 1 month. Karan receives ₹2,46,000 in gratuity. Priya receives nothing.
Two months made a ₹2.46 lakh difference. Gratuity is one of the few places in Indian employment law where a single day separates receiving a lump sum from losing it entirely.
What gratuity is
Gratuity is a statutory payment employers must make to employees upon leaving after completing 5 or more years of continuous service. It’s governed by the Payment of Gratuity Act, 1972.
It’s not a bonus or goodwill payment — it’s a legal obligation. Employers who refuse to pay can be prosecuted, and the amount due can be recovered through the Controlling Authority under the Act.
Gratuity is funded by the employer, not deducted from your salary. When your CTC breakdown shows “gratuity accrual” as a line item, that’s the employer provisioning for this liability — it’s money being set aside for you, not taken from you.
Who qualifies
Primary rule: 5 years of continuous service with the same employer.
“Continuous service” allows for interruptions due to illness, accident, leave (paid or unpaid), lockout, or strike — as long as the employee was not terminated. A gap due to maternity leave also counts as continuous service.
Exceptions that reduce the threshold:
- Death or disability: If an employee dies or becomes permanently disabled before completing 5 years, gratuity is payable regardless of tenure. The formula uses actual years served.
- Some courts have ruled 4 years 240 days qualifies: In certain High Court interpretations, completion of 4 years and 240 days (for employees working 6 days a week) or 4 years and 190 days (5-day week) has been treated as satisfying the 5-year requirement. This is contested and not uniformly applied — don’t plan around it without checking your state’s position.
Who is covered: Employees at organisations with 10 or more workers in any day of the preceding 12 months. Once covered, an organisation remains covered even if headcount falls below 10.
Who is excluded: Employees in the apprentice category, government employees covered under separate schemes, and some seasonal workers.
The formula
Gratuity = (Last drawn basic salary × 15 × completed years of service) ÷ 26
- Basic salary here means basic + dearness allowance (DA). It does not include HRA, special allowance, bonus, or other variable components.
- 15 represents 15 days of salary per year of service.
- 26 is the number of working days in a month assumed by the Act (not 30 or 31).
- Completed years — a year must be fully completed. 4 years 11 months counts as 4 years. The exception noted above (240 days) is a contested legal position, not a guaranteed entitlement.
Example — Karan at 5 years 1 month:
| Monthly basic salary | ₹85,000 |
| Completed years | 5 |
| Gratuity | (₹85,000 × 15 × 5) ÷ 26 |
| ₹2,45,192 |
The extra 1 month doesn’t add to the multiplier. Only completed years count. At year 6, it would recalculate with 6.
Maximum gratuity under the Act: ₹20 lakh. This ceiling was raised from ₹10 lakh in 2018 and applies to government-notified organisations. Some companies voluntarily pay higher — anything above ₹20 lakh is still payable, but the tax exemption caps at ₹20 lakh.
Tax treatment
Gratuity received on retirement, resignation, or death is partially or fully exempt under Section 10(10).
For employees covered by the Gratuity Act (private sector): Exempt amount = least of:
- Actual gratuity received
- ₹20 lakh (lifetime limit across all employers)
- (Last basic salary × 15 × completed years) ÷ 26
For most employees, the calculated amount will be lower than ₹20 lakh, making the entire gratuity tax-free.
For employees not covered by the Act (e.g., certain private firms below 10 headcount): Exempt = least of:
- Actual gratuity
- ₹20 lakh
- Half month’s average salary for each completed year (average of last 10 months)
For government employees: Fully exempt — no ceiling applies.
The ₹20 lakh limit is a lifetime cumulative limit across all employers. If you’ve received ₹15 lakh tax-free gratuity from a previous employer and receive ₹8 lakh more from the next, only ₹5 lakh of the second tranche is exempt. The remaining ₹3 lakh is added to income and taxed at your slab rate.
When gratuity is paid
| Situation | When payable |
|---|---|
| Resignation after 5+ years | Within 30 days of last working day |
| Retirement | Within 30 days |
| Death (to nominee or legal heir) | Within 30 days |
| Permanent disability | Within 30 days |
If payment is delayed beyond 30 days, the employer owes simple interest at 10% per annum on the outstanding amount for the delay period. You can file a claim with the Controlling Authority (typically the Labour Commissioner) if your employer delays.
Gratuity in your CTC vs what you actually receive
Most CTC letters include a line item like “Gratuity: ₹X.” This is the employer’s annual provision — 4.81% of basic salary (derived from the formula: 15/26 × 1/12 × basic).
This amount is accrued by the employer, often in a gratuity fund. It does not appear in your payslip as income or deduction. You only receive it as a lump sum when you leave — and only if you’ve completed 5 years.
If you leave before 5 years, that accrual stays with the employer. The gratuity component in your CTC is not your money until you’ve served the qualifying period.
The near-miss problem
The most financially significant gratuity decision most employees face is whether it’s worth staying an extra few months to cross the 5-year mark.
Quick calculation to decide:
- Calculate your gratuity entitlement after 5 years: (Basic × 15 × 5) ÷ 26
- Compare against the monthly income gain from the new job
- If the gratuity is larger than 1–2 months of gain, staying is likely worth it
At ₹15 LPA with ₹6 lakh basic:
- Gratuity at 5 years: (₹50,000 × 15 × 5) ÷ 26 = ₹1,44,231 tax-free
If the new job offers ₹50,000 more per month, the gratuity crossover takes about 3 months. If the gain is ₹20,000/month, it takes 7 months. The calculation is simple and often reveals the decision.
Frequently asked questions
Does gratuity appear in my Form 16? Tax-exempt gratuity does not appear as income in Form 16 or your ITR. If any portion exceeds the ₹20 lakh lifetime limit and is taxable, it would appear under “Profits in lieu of salary” in Part B of Form 16.
What if my employer refuses to pay? File a claim in writing with your employer, then with the Controlling Authority (Labour Commissioner) in your district. Claims must be filed within 60 days of the gratuity becoming due. The authority can direct payment plus interest. Wilful refusal carries criminal liability for the employer.
Does the gratuity formula change if I was promoted? The formula uses the last drawn basic salary — not an average. A recent promotion that increased your basic significantly before resignation works in your favour.
What happens to gratuity if my company shuts down? The gratuity liability is a statutory debt. It ranks above most other unsecured creditors in insolvency. If the company maintained a gratuity fund (as most large employers do), those funds are ringfenced and should be accessible through the insolvency process.
Is gratuity paid for contract employees? Workers engaged through contractors are covered by the Act if the principal employer’s organisation meets the headcount threshold. In practice, enforcement varies — contract workers often have to pursue claims actively.
Verified against Payment of Gratuity Act, 1972 and incometax.gov.in (June 2026). Maximum exemption limit of ₹20 lakh effective March 2018 per government notification.
This guide is for informational purposes. Eligibility may vary — consult an HR or legal professional for your specific situation.