Is Your Gratuity Taxable?
₹20L Limit, Formula & 2026 Rules

A private sector employee with 20 years of service and a ₹1L/month basic salary receives ₹11.5 lakh as gratuity. The tax-exempt portion, calculated using the 15/26 formula, is ₹11.5L , fully exempt because it is below the ₹20L ceiling and below the formula result. The same employee at ₹2L/month basic after 25 years gets ₹43.2L. The exempt portion is capped at ₹20L. The remaining ₹23.2L is taxable as salary in the year of receipt and, if it pushes them into the 30% slab, is worth knowing about long before the day they retire. Planning starts years in advance, not the day you receive the cheque.

1. What Is Gratuity and When Is It Paid?

Gratuity is a lump-sum payment made by an employer to an employee as recognition of their long-term service. It is governed by the Code on Social Security, 2020 (which consolidated the earlier Payment of Gratuity Act, 1972, effective November 2025) and is payable on any of the following events:

• Superannuation (retirement at the age prescribed by the employer or service rules)
• Resignation after completing the minimum service period
• Retirement on reaching a mandatory retirement age
• Death of the employee (paid to nominee or legal heir; minimum service not required)
• Disablement due to accident or disease (minimum service not required)

The minimum service period for regular employees is five years of continuous service. Gratuity is not payable on resignation or retirement before completing five years, with the exception of death and disablement. Under the new Code on Social Security, fixed-term employees become eligible after completing one year of service (versus five years for permanent employees), significantly expanding coverage.

From a tax perspective, gratuity is treated as “Income from Salaries” under Section 17 of the Income Tax Act, but Section 10(10) provides partial or full exemption depending on the employee category. The specific exemption formula differs significantly between government and private sector, and between Act-covered and non-covered private sector employees. Because gratuity is calculated on basic salary and DA, your basic-to-CTC salary ratio directly determines the size of your eventual gratuity payout.

2. The Three Categories: Which One Are You?

Section 10(10) creates three distinct categories for gratuity taxation. Knowing which category applies to you is the first step before any calculation.

3. Government Employees: Completely Tax-Free, No Ceiling

For employees of the central government, state governments, defence services, civil services, and local authorities, the entire gratuity received on retirement, superannuation, or death is fully exempt from income tax under Section 10(10)(i). There is no monetary ceiling on this exemption. Whether the gratuity is ₹5L or ₹50L, the full amount is non-taxable.

For central government employees, gratuity is calculated as one-quarter of last drawn pay (basic + DA) for each completed six-month period of qualifying service. As of January 2024, the government raised the maximum gratuity payable to central government employees to ₹25 lakh. But regardless of the amount received, the entire gratuity remains tax-exempt under Section 10(10)(i).

4. Private Sector (Act Covered): The 15/26 Formula

For private sector employees whose employer is covered under the Payment of Gratuity Act (Category 2), the tax-exempt gratuity is the minimum of three figures:

What “salary” means here: For the formula, salary means Basic Pay plus Dearness Allowance only. Special allowance, HRA, commission (unless based on fixed percentage of turnover), and other components are excluded. This is a frequently misunderstood point. If your CTC is ₹20L but your basic is ₹7L, the gratuity formula uses ₹7L (plus DA if any, which is typically zero in private sector) — not the full CTC figure.

5. Private Sector (Not Covered): The Half-Month Formula

For employers not covered under the Payment of Gratuity Act (Category 3), the exemption formula under Section 10(10)(iii) is different. The tax-exempt portion is the minimum of three figures:

6. Worked Examples: From ₹5L to ₹43L Gratuity

Three worked examples across different salary levels and tenures to show how the formula plays out.

*In Example 3, the employer paid ₹8L but the formula only permits ₹6L to be exempt. The ₹2L excess is taxable even though the total is well below ₹20L. The formula constraint (not just the ₹20L ceiling) is binding here. This is a common scenario for non-Act employers who pay generous gratuity beyond the formula amount. The exact exempt and taxable split for your basic salary and tenure can be computed with the Gratuity Calculator.

7. The ₹20L Ceiling Is Cumulative Across Your Entire Career

This is the most commonly missed rule in gratuity taxation. The ₹20 lakh exemption limit is not a per-employer limit. It is a lifetime cumulative limit that covers all gratuity received from all employers across your entire career. If you change jobs multiple times and receive gratuity from multiple employers, the total tax-exempt gratuity across all of them cannot exceed ₹20 lakh.

*In this example, after receiving ₹12.5L in gratuity from Employers A and B, only ₹7.5L of the ₹20L lifetime exemption remains. When Employer C pays ₹22L in gratuity, only ₹7.5L is exempt and ₹14.5L is taxable as salary. Many employees are unaware of this cumulative tracking and assume each employer gives a fresh ₹20L exemption. You must track the total exemption used across all prior employers when declaring gratuity in your ITR.

8. Gratuity Received During Service: Fully Taxable

A critical distinction: the Section 10(10) exemption applies only to gratuity received at or after retirement, resignation, death, or disablement. If your employer pays you gratuity during your active service period (for example, as a long-service award or as part of a restructuring payment), that amount is fully taxable as salary with no exemption under Section 10(10).

This scenario is uncommon but does occur in certain industries where employers pay interim gratuity or where a company acquisition involves paying out accumulated gratuity to employees who continue working. Any such payment during active employment is treated as perquisite or salary and taxed at the full slab rate. The exemption provisions do not apply until the qualifying event (separation from service) occurs.

9. Gratuity on Death or Disablement: Special Rules

When gratuity is triggered by the death or permanent disablement of an employee, two important modifications apply. First, the five-year minimum service requirement is waived: gratuity is payable regardless of how long the employee served, as long as they had a minimum of one year of continuous service (for regular employees under the Act). Second, the gratuity is paid to the nominee or legal heir of the deceased employee.

Note the head-of-income distinction for death: when a nominee or legal heir receives gratuity on the death of an employee, it is classified as “Income from Other Sources” in the heir’s hands (not salary), but the same Section 10(10) exemption limits still apply. The heir is not independently liable for the employee’s tax obligations; the gratuity received is the heir’s own income, exempt up to the applicable limit.

10. Section 89 Relief: The Tax Break for Lump-Sum Gratuity

Even after the ₹20L exemption, a salaried employee receiving ₹5–15L in taxable gratuity faces an acute problem: their taxable income spikes in the year of receipt, potentially pushing them into the 30% slab just for that one year. Section 89(1) of the Income Tax Act exists precisely to address this situation. This is also the year when carefully comparing old vs new tax regime matters most, since the regime affects how the taxable gratuity is ultimately charged.

11. New Labour Code Impact on Gratuity Calculation in 2026

The Code on Wages, 2019, and the Code on Social Security, 2020, both now effective (November 2025 implementation), have changed how “wages” are defined for the purpose of gratuity calculation. This directly affects the formula amount and therefore the tax-exempt portion. The same wage definition change also increases the EPF contribution base for many employees whose basic was artificially suppressed below 50% of CTC.

Under the new codes, wages must be at least 50% of total CTC. If your CTC structure has basic salary below 50% of total (which is very common in Indian private sector where allowances are inflated to reduce gratuity and PF), the excess of allowances above 50% of CTC is notionally added to wages for calculation purposes. This increases the effective gratuity base and therefore the formula-calculated exempt amount.

*The 50% wage rule means employers can no longer depress gratuity by setting a very low basic salary ratio. Employees who were in firms with artificially low basic (15–25% of CTC) will see significantly higher gratuity payouts and higher exempt amounts under the new code. Employers are adjusting salary structures to comply. Verify your current basic-to-CTC ratio with HR and understand how it affects your projected gratuity entitlement.

12. Gratuity Forfeiture: When the Employer Can Withhold

Gratuity is a statutory right, but it can be forfeited partially or fully in specific circumstances under the Payment of Gratuity Act / Code on Social Security:

• Wilful omission or negligence causing damage or loss: The employer can forfeit gratuity to the extent of the damage or loss proven. Example: an employee who deliberately damaged machinery worth ₹5L could have that amount deducted from their ₹8L gratuity, leaving ₹3L payable.
• Offence involving moral turpitude: If employment is terminated for an offence involving moral turpitude (theft, fraud, sexual harassment), the entire gratuity can be forfeited.
• Poor performance alone is not grounds for forfeiture. An employer cannot withhold gratuity simply because the employee resigned, had performance issues, or left abruptly without notice (unless the notice period serves as the contractual basis for deduction, which is a separate matter).

From a tax perspective: any gratuity amount forfeited is not received by the employee and is therefore not taxable. If the employer pays a reduced amount after forfeiture, only the amount actually received is relevant for Section 10(10) exemption calculation.

13. Gratuity in CTC: The 4.81% Provision

When companies calculate CTC (Cost to Company), they typically include a “Gratuity provision” line item of approximately 4.81% of annual basic salary. This figure comes from the formula: 15/26 × basic = 0.5769 × basic per year of service, which on a monthly basis is 0.5769/12 = 4.81% of monthly basic.

This CTC component is often a source of confusion. Key facts:

• The CTC gratuity line is an employer provision, not your monthly income. It does not get paid to you each month.
• The provision accumulates as an employer liability and is paid as a lump sum only when you leave after qualifying.
• If you leave before 5 years of service, you forfeit the entire accumulated gratuity provision and receive nothing from this CTC component.
• The CTC gratuity provision is not taxable in your hands while you are employed. It only becomes potentially taxable when you actually receive it on separation.

For a ₹20L CTC employee with ₹8L basic, the gratuity provision in CTC is approximately ₹38,500/year (4.81% of ₹8L). Over 10 years, this accumulated provision of approximately ₹3.85L is what the employer has set aside for your gratuity. Your actual gratuity at the formula rate would be ₹8L × 15 × 10 ÷ 26 = ₹4,61,538 which the employer must pay regardless of the provision balance. When modelling your retirement corpus, treat the expected gratuity as a lump-sum addition to your EPF and investment returns, not as monthly income.

14. How to Report Gratuity in Your Income Tax Return

Reporting gratuity in the ITR correctly requires distinguishing between the exempt and taxable portions and ensuring consistency between what you declare and what your employer reports in Form 16.

Step 1: Get the Gratuity Certificate from Your Employer

Your employer must provide a gratuity certificate or a breakup showing the total gratuity paid and the tax-exempt portion calculated under Section 10(10). This should also appear in Part B of Form 16 under “Exempt Allowances under Section 10.”

Step 2: Verify Against Your Own Calculation

Cross-check the employer’s claimed exempt amount against your own formula computation. If the employer is using a lower basic salary than your current last-drawn (for example, they averaged something), the exempt amount may be understated. You are entitled to use your actual last-drawn basic + DA in the formula.

Step 3: Report in ITR

In ITR-1 or ITR-2, the taxable gratuity (amount above the exempt portion) is included under “Income from Salaries” and should already appear in Form 16. The exempt portion is declared under “Exempt Income under Section 10” in Schedule EI or the relevant exempt income schedule. The total tax liability with gratuity added to salary can be estimated before filing to avoid surprises.

Step 4: File Form 10E Before ITR (If Claiming Section 89 Relief)

If the taxable gratuity creates a higher slab liability, compute and file Form 10E on the income tax portal before submitting your ITR. Enter the gratuity breakup, years of service, and prior year income data. The portal auto-calculates the Section 89 relief. Only then proceed to file the ITR and claim the relief in the appropriate schedule.