Gratuity: How To Calculate, Rules,

Eligibility and Formula

How Gratuity is Calculate
The gratuity amount depends upon the tenure of service and last drawn salary.
It is calculated according to this formula: Last drawn salary (basic salary plus
dearness allowance) X number of completed years of service X 15/26.

According to this formula, the time period of over six months or more is
considered as one year.

This means if you have completed five years and seven months of service, the
number of years would be considered as six years for calculation of gratuity
benefit.

On the other hand, if the service period is five years and five months, for
gratuity calculation it will be considered five years.

An employer can however give higher gratuity than the amount under the
prescribed formula.

Maximum Amount

For government employees, Rs. 20 lakh is the maximum amount that can be
paid as gratuity. The Seventh Pay Commission had recommended increase in
the gratuity ceiling to Rs. 20 lakh from the earlier level of Rs. 10 lakh.

Income Tax Treatment of Gratuity

For government employees, entire amount of gratuity received on retirement or
death is currently exempted from income tax.

In case of non-government employees, income tax rules on gratuity are

applicable depending on whether employees are covered under the Payment of
Gratuity Act, 1972 or not.

For non-government employees covered under the Gratuity Act, the

income tax exemption on any gratuity received is least of the following:

 Maximum amount specified by the government which is currently Rs. 10

lakh
 Last drawn salary X 15/26 X years of service
 Actual gratuity received

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For example, the last drawn salary (basic plus DA) of Mr Ashish, for example, is
Rs. 60,000 (per month) and he has worked for 25 years. The gratuity according
to the formula is Rs. 8.65 lakh but suppose he has actually received gratuity of
Rs. 12 lakh.

So for income tax calculation, Rs. 8.65 lakh will be considered for exemption.
So Mr Ashish will pay tax on Rs. 3.35 lakh (Rs. 12 lakh - 8.65 lakh).

Comments
For non-government employees not covered under the Payment of
Gratuity Act, the income tax exemption on any gratuity received is least of the
following:

 Half month's average salary for each completed year of service

 Maximum amount specified by the government which is currently Rs. 10
lakh
 Actual gratuity received

(Average monthly salary is to be computed on the basis of average of salary for

10 months immediately preceding the month (not the day) of retirement)

For example, the last drawn salary (basic plus DA) of Mr Bhupesh, for example,
is Rs. 70,000 and he has worked for 35 years. The gratuity according to the
formula is Rs. 12.25 lakh and he has received this amount as gratuity. For tax
purposes, Rs. 10 lakh would be considered as exemption limit as it is the
lowest of the three factors. So Mr Bhupesh will have to pay tax on Rs. 2.25
lakh (Rs. 12.25 lakh - Rs. 10 lakh).