Gratuity is one of those numbers that shows up on a final settlement letter and confuses almost everyone reading it. This guide walks through who gets it, how it's calculated, and how much of it you actually keep after tax. Use the gratuity calculator alongside this if you want to plug in your own numbers as you go.
What Is Gratuity and Who Is Eligible
Gratuity is a lump-sum payment an employer makes to an employee as a thank-you for long service. It's separate from your salary, provident fund, or any bonus. It's governed in India by the Payment of Gratuity Act, 1972, and most people first run into the term when they're using a gratuity calculator to check what they're owed at retirement or resignation.
Eligibility for gratuity comes down to one main rule: five years of continuous service with the same employer. "Continuous service" isn't as strict as it sounds. Under Section 2A of the Act, it still counts if you were on approved leave, sick leave, or a legal strike during that period. There's also a well-established exception known as the 240-day rule: if you've completed four years and worked at least 240 days in the fifth year (190 days for underground mine or seasonal workers), several High Courts have accepted that as meeting the five-year requirement.
The five-year condition applies to resignation and retirement. It does not apply if gratuity is being paid because the employee died or became permanently disabled while still employed. That case is covered further down.
Not every employer falls under the Act. It applies to factories, mines, plantations, ports, railways, and any shop or establishment with 10 or more employees on any day in the preceding 12 months. Once an establishment is covered, it stays covered even if the headcount later drops below 10.
Who typically qualifies:
- Private sector employees who've completed 5 years at one employer covered by the Act
- Employees of factories, companies, and establishments with 10+ staff
- Government employees, under a separate but similar framework
Who typically doesn't:
- Employees with under 5 years of service (barring death or disability)
- Interns, apprentices, or those not classified as "employees" under the Act
- Staff at establishments with fewer than 10 employees (unless the employer opts in voluntarily)
If you're unsure whether your employer is covered, your appointment letter or HR policy document usually states it directly, or you can ask HR to confirm.
The Gratuity Formula: (Salary × 15 × Years) ÷ 26
For employees covered under the Payment of Gratuity Act, the formula for gratuity is:
Gratuity = (Last drawn salary × 15 × Number of years of service) ÷ 26
Here, "last drawn salary" means basic pay plus dearness allowance (DA). It's not your full CTC, and it doesn't include HRA, bonus, or special allowance. The "15" represents 15 days of salary for each completed year of service, and "26" is the number of working days assumed in a month, based on a 6-day work week that excludes Sundays. Any service period of 6 months or more past a full year gets rounded up to the next full year.
Here's the gratuity computation worked through at two salary levels and three tenures, using the covered-employee formula:
| Last Drawn Salary | 5 Years of Service | 10 Years of Service | 20 Years of Service |
|---|---|---|---|
| ₹40,000 | ₹1,15,385 | ₹2,30,769 | ₹4,61,538 |
| ₹80,000 | ₹2,30,769 | ₹4,61,538 | ₹9,23,077 |
Take the ₹80,000 salary, 10-year row as an example: (80,000 × 15 × 10) ÷ 26 = 12,00,000 ÷ 26 = ₹4,61,538 (rounded to the nearest rupee). Double the years to 20 and the gratuity roughly doubles too, since the formula is linear in years of service once salary is fixed.
The Payment of Gratuity Act also caps what an employer is statutorily required to pay at ₹20,00,000, regardless of what the formula produces. An employer can choose to pay more, but they're only legally bound up to that ceiling. That cap is a separate rule from the tax-exemption limit in the next section, even though the two happen to sit at the same figure right now.
Covered vs Not-Covered Under the Gratuity Act
Not every employee falls under the Payment of Gratuity Act, and the gratuity rule that applies to you changes the formula in a small but meaningful way.
For employees covered under the Act, the calculation uses 15 days of the last drawn salary (basic + DA) per year of service, divided by 26 working days a month:
Gratuity = (Salary × 15 × Years) ÷ 26
For employees not covered under the Act, say staff at an establishment with fewer than 10 employees that hasn't opted in, the calculation instead uses a half-month's average salary based on the last 10 months, divided by 30 calendar days a month:
Gratuity = (Average salary of last 10 months × 15 × Years) ÷ 30
The difference between 26 and 30 as the divisor, plus the switch from "last drawn" to a 10-month average, usually means non-covered employees end up with a somewhat lower payout for the same salary and tenure. Here's how that plays out using the same salary figures as before:
| Salary Basis | 5 Years | 10 Years | 20 Years |
|---|---|---|---|
| ₹40,000, covered (÷26) | ₹1,15,385 | ₹2,30,769 | ₹4,61,538 |
| ₹40,000, not covered (÷30) | ₹1,00,000 | ₹2,00,000 | ₹4,00,000 |
| ₹80,000, covered (÷26) | ₹2,30,769 | ₹4,61,538 | ₹9,23,077 |
| ₹80,000, not covered (÷30) | ₹2,00,000 | ₹4,00,000 | ₹8,00,000 |
Both formulas still require 5 years of service (subject to the same 240-day exception), and both are still subject to the ₹20 lakh statutory and tax-exemption ceilings described elsewhere in this guide. The main practical takeaway: check your appointment letter or ask HR which category you fall under before you rely on a gratuity number for financial planning.
Tax Exemption Limit on Gratuity
Whether gratuity is taxable depends on who you work for and how much you receive.
Government employees, whether central, state, or local authority, get their entire gratuity tax-free under Section 10(10)(i) of the Income Tax Act, with no upper monetary cap.
Private sector employees covered under the Payment of Gratuity Act get an exemption on the least of the following three amounts:
- The actual gratuity received
- ₹20,00,000 (the current exemption ceiling under Section 10(10)(ii))
- The amount calculated using the 15/26 formula
Anything above that "least of" figure is added to your taxable salary income for the year and taxed at your applicable slab rate.
Take the ₹80,000 salary, 20-year example from earlier: the formula gives ₹9,23,077, which is comfortably under the ₹20 lakh cap. In that case the full ₹9,23,077 is tax-free. It's only once the formula-based amount, or the actual payout, starts approaching ₹20 lakh that a portion becomes taxable.
One detail catches a lot of people off guard: the ₹20 lakh exemption is a lifetime cumulative limit, not a per-employer one. If you already claimed exemption on ₹8 lakh of gratuity from an earlier job, only ₹12 lakh of exemption is left for every job you take afterward. Anything received beyond that combined ₹20 lakh, from any employer, gets taxed.
The exemption holds under both the old and new tax regime. Section 10(10) isn't among the deductions the new regime strips out, unlike most Chapter VI-A deductions. If you're estimating your own numbers, running them through a gratuity and tax calculator is easier than doing the "least of three" comparison by hand, since it's easy to overlook one of the three limits.
Because exemption thresholds are set by government notification and can change, always check the current limit before finalizing a large gratuity-related tax calculation.
Gratuity on Death or Disability Before 5 Years
The 5-year service rule has one major exception: it doesn't apply if the gratuity is being paid because the employee died, or became permanently disabled, while still employed.
In these cases, the gratuity amount is payable regardless of how long the employee had actually worked, even if that's just a year or two. The amount is paid to the employee's nominee (or legal heir, if no nominee was registered) in the case of death, or to the employee directly in the case of disability.
The tax treatment here is also more favourable. Gratuity paid on death or permanent disability is generally treated as fully tax-free in the hands of the recipient, regardless of the ₹20 lakh exemption limit that applies in ordinary retirement or resignation cases. This is because it's treated as a capital receipt tied to the employee's death or incapacity, rather than as income earned through continued service.
This exception matters most for younger employees who might otherwise assume gratuity isn't relevant to them yet, simply because they haven't hit the 5-year mark. It's also worth registering a nominee for gratuity early, through Form F under the Act, so there's no ambiguity about who the payment goes to if this situation comes up.
Frequently Asked Questions
What is the minimum service period to be eligible for gratuity?
Five years of continuous service with the same employer, in most cases. Approved leave, sick leave, and legal strikes still count toward this period. The 240-day rule is a recognized exception: completing 4 years plus 240 working days in the fifth year has been accepted by several courts as satisfying the requirement. The 5-year rule doesn't apply at all if gratuity is being paid due to death or permanent disability.
Is gratuity taxable, and up to what amount is it tax-free?
Government employees get full tax exemption with no cap. Private sector employees covered under the Act get exemption on the least of the actual gratuity received, ₹20 lakh, or the amount from the 15/26 formula. This ₹20 lakh limit is cumulative across your entire career, not reset per employer. Anything paid above the exempt amount is taxed as salary income at your slab rate.
What's the difference in formula for employees not covered by the Gratuity Act?
Covered employees use (Salary × 15 × Years) ÷ 26, based on last drawn basic salary plus DA. Employees not covered by the Act use (Average salary of last 10 months × 15 × Years) ÷ 30. The switch from a 26-day to a 30-day divisor, and from last-drawn to an averaged salary, typically produces a slightly lower gratuity for the same tenure and pay.
Is gratuity paid if an employee resigns before 5 years?
Generally, no. Resignation before completing 5 years of continuous service (or the 240-day equivalent in year five) means no gratuity is payable under the Act. The only exceptions are death or permanent disability, where the 5-year requirement is waived entirely.
In Short
Gratuity depends on three things: whether your employer falls under the Payment of Gratuity Act, how many years you've completed, and your last drawn salary. Once you know which formula applies to you, working out the number is straightforward. For a quick, personalized calculation, use the gratuity calculator, and check the complete gratuity rules guide for a deeper look at eligibility edge cases and recent changes to the law.
Sources
- Payment of Gratuity Act, 1972: full text via India Code (eligibility rules, the 15/26 formula, and the ₹20 lakh statutory ceiling)
- Income Tax Act, 1961, Section 10(10): Income Tax Department (tax exemption on gratuity)
- Income Tax Department clarification on the ₹20 lakh exemption limit: confirms the limit was raised from ₹10 lakh to ₹20 lakh, effective for payments on or after 29 March 2018
Tax exemption limits are set by government notification and can change. Confirm the current figure on the Income Tax Department's website before relying on it for a large gratuity calculation.