How gratuity is calculated and taxed
Gratuity is a lump sum your employer pays for long service. For establishments covered by the Payment of Gratuity Act, the amount is fixed by a formula rather than negotiated, and it becomes payable once you complete five years of continuous service.
Formula
Gratuity = (15 ÷ 26) × last drawn monthly salary × completed years of service
- Salary means basic pay plus dearness allowance, not total CTC
- 26 represents working days in a month; 15 represents half a month’s pay per year
- Service beyond six months in the final year is generally rounded up to a full year
- Five years of continuous service is normally required, with an exception for death or disablement
Where the 15 by 26 comes from
The Act treats a month as 26 working days and awards 15 days of pay for each completed year. That works out to roughly 57.7% of a month’s salary per year of service — on a ₹50,000 basic, about ₹28,846 for every year you stayed.
Because only basic and dearness allowance count, an employee whose salary is heavily weighted towards allowances receives less gratuity than a colleague on the same CTC with a higher basic.
The five-year threshold and rounding
Complete five years and you qualify; leave at four years and eleven months and normally you do not. Some judicial decisions have allowed a year of 240 working days to count, but the safe assumption is the full five years.
Beyond that, the final year rounds up when you have served more than six months. Ten years and seven months is treated as eleven years, which is worth about half a month’s salary.
How much is tax-free
For non-government employees covered by the Act, gratuity is exempt up to the least of the amount received, the formula amount, and a lifetime ceiling of ₹20 lakh. The ceiling applies across your whole career, not per employer.
Anything above the exempt limit is taxed as salary income in the year of receipt. Government employees receive gratuity fully exempt.
When employers are not covered by the Act
Establishments with fewer than ten employees may fall outside the Act. Some still pay gratuity voluntarily, often using a formula of half a month’s salary for each completed year — based on a 30-day month rather than 26, which produces a smaller amount.
Check your appointment letter or company policy. Where gratuity is contractual rather than statutory, the terms are whatever the policy states.
Example: 10 years on a ₹50,000 basic
- Last drawn basic + DA
- ₹50,000 a month
- Completed years of service
- 10
- Per year of service
- ≈ ₹28,846
- Gratuity payable
- ≈ ₹2,88,462
- Exempt limit
- ₹20 lakh (lifetime)
- Taxable portion
- Nil
Staying one more full year would add about ₹28,846, and any salary increase before you leave raises the whole amount because the formula uses your last drawn salary.