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. This makes the 5-year mark a meaningful financial threshold when evaluating a job switch — the gratuity entitlement you forfeit by leaving early should be factored into the monthly in-hand comparison between your current role and a new offer. 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).

The ₹25 lakh government ceiling: what most sources miss

The government has quietly increased the maximum gratuity payable to central government employees to ₹25 lakh, effective January 1, 2024. This is separate from the ₹20 lakh tax exemption ceiling that applies to private sector employees. For central government employees, the entire ₹25 lakh (or more, depending on rules at the time) remains fully tax-free under Section 10(10)(i), since government employees have no monetary ceiling on the exemption. State government gratuity ceilings vary by state; check the latest notification from your respective state finance department.

Fixed-term employees: the 2026 change that expands gratuity eligibility significantly. Under the Code on Social Security, 2020, effective from November 2025, fixed-term employees (FTEs) , those on contracts with a defined end date , become eligible for gratuity after completing just one year of continuous service, compared to five years for permanent employees. This is a major expansion. An FTE hired for a 2-year project who completes the project is now entitled to gratuity proportional to their service. This change affects large numbers of IT, manufacturing, and gig-economy adjacent workers hired under fixed-term contracts.

New tax regime and gratuity: the CBDT Circular 06/2025 update. Under the old tax regime, government employees enjoy full exemption and private employees enjoy exemption up to ₹20 lakh. Under the new tax regime (Section 115BAC), the full ₹20 lakh exemption was previously unavailable. However, CBDT Circular No. 06/2025 (dated May 2025) clarified that gratuity up to ₹5 lakh is now exempt even under the new tax regime for retirement, resignation, or death-related gratuity. This partial new-regime exemption is an important 2026 development. If your gratuity is below ₹5 lakh, the new regime does not disadvantage you on gratuity. Above ₹5 lakh, the old regime's ₹20 lakh ceiling is more beneficial and should be factored into your tax regime decision in the year of retirement.

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. When comparing two offers with different basic salary percentages, this also changes the gratuity entitlement you are accumulating, not just the monthly in-hand.

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:

Why the average salary formula matters for variable pay employees

The 10-month average salary base in Section 10(10)(iii) is not just a technical detail , it significantly affects the exempt amount for employees with variable pay components. Consider a senior consultant who received a ₹3L performance bonus in their final quarter before resignation. Under Section 10(10)(ii) (Act-covered), the formula uses only last drawn basic + DA , bonuses are excluded. Under Section 10(10)(iii) (not-covered), the formula uses average of last 10 months' salary including commission based on a fixed percentage of turnover, if applicable. For most private sector employees without turnover-linked commission, the formula still excludes bonuses and variable pay, making the exempt amount similar to Category 2.

When can a private sector employee be in Category 3? Three situations are most common: startups and small businesses with fewer than 10 employees at any point in the preceding 12 months; international NGOs and foreign consulates registered in India but not covered under the Act; and employers who pay gratuity voluntarily beyond the Act's requirements, where the excess over the Act-mandated amount may fall under Section 10(10)(iii) for the surplus portion. If you are unsure of your category, the safe test is whether your employer has ever received an EPFO or gratuity compliance notice , Act-covered employers generally have a track record with the labour department. The distinction matters because it determines which formula limits your tax-exempt amount, even though both categories share the ₹20L ceiling.

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.

Tracking exemption used: your responsibility, not the tax department's

The Income Tax Department does not automatically track your cumulative gratuity exemption history across employers. When you file your ITR in the year you receive gratuity, you declare the amount received and compute the exempt portion. If you have received gratuity from prior employers, you must manually track what portion of the ₹20L ceiling was used. This information is available in your old Form 16s and ITRs. Maintain a simple record: employer name, year of gratuity receipt, amount received, amount claimed as exempt. This is especially important for mid-career switchers who have worked at 3-4 companies. Use the Income Tax Calculator to model the final year's tax liability once you know the remaining exemption and the taxable gratuity amount.

What happens if you incorrectly claim the full ₹20L exemption when part was used before? The excess claim is an incorrect deduction and will be disallowed during scrutiny or Section 143(1) processing. The additional tax plus interest under Section 234B/234C will be levied. Since gratuity from large employers is typically reflected in Form 26AS (the annual tax statement available on the income tax portal), any discrepancy between what you claim and what is reported is likely to attract automated scrutiny. Keep your exemption records clean and accurate across your career. Consult a chartered accountant in the retirement year if your gratuity is large or you have complex multi-employer history.

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.

Company acquisition and restructuring: the mid-career gratuity trap

The most common mid-career scenario where gratuity is paid during service is a company acquisition. When Company A acquires Company B and decides to settle all accumulated gratuity liabilities, employees of Company B who continue working after the acquisition may receive a gratuity payout from Company B's old entity before being re-onboarded by Company A. This payment during active service is fully taxable , there is no exemption under Section 10(10) since the qualifying event (separation) has not occurred. The net effect: the employee receives cash they did not need yet, pays full slab-rate tax on it, loses the compounding on that amount within the gratuity fund, and starts fresh with Company A from zero years for future gratuity accumulation.

If you receive a gratuity payout during service due to restructuring, inform your HR of the tax implications. The employer should deduct TDS at the applicable slab rate (or the employee should pay advance tax). Unlike gratuity at retirement where the exemption reduces the taxable base significantly, a mid-service gratuity payment has no such buffer. The payout should ideally be deployed immediately in a tax-efficient instrument , the ₹20L exemption ceiling is not consumed by this payment since no exemption was applicable. The ceiling remains fully intact for the actual retirement or resignation event. Track this carefully when computing future exemptions.

VRS (Voluntary Retirement Scheme) gratuity: a different and important scenario. When an employer offers VRS, the gratuity paid as part of VRS compensation is subject to the same Section 10(10) rules as regular retirement gratuity. The VRS compensation itself (separate from gratuity) has its own exemption under Section 10(10C) up to ₹5 lakh. These are two separate exemptions. A VRS employee in the 55-59 age group receiving both VRS compensation and gratuity should plan both exemptions carefully. This is also the demographic that should prioritise opening an SCSS account within one month of receiving retirement benefits, as per the SCSS eligibility window for early retirees.

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 CTC (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.

The employer's 30-day payment obligation and interest on delay

Under the Payment of Gratuity Act, the employer must pay gratuity within 30 days of the date it becomes payable. The date it becomes payable is the date of retirement, resignation, or (in death cases) when the nominee submits the claim. Delay beyond 30 days attracts simple interest at the rate specified by the government (currently 9-10% per annum), payable from the date it was due. This interest is taxable as income from other sources in the hands of the employee.

How to claim gratuity: the formal process most employees skip. The employee (or nominee in case of death) must file Form I under the Payment of Gratuity Act with the employer. Employers with 500+ employees are required to have a gratuity trust; others pay through the government's LIC Group Gratuity scheme or directly. The employer must acknowledge the claim within 15 days and either pay within 30 days or dispute the claim in writing. If disputed, the matter goes to the controlling authority (typically the labour commissioner). Most employees at large formal-sector firms receive gratuity automatically at F&F settlement without needing to file Form I, but knowing the right exists protects you if the employer delays or disputes.

Dispute resolution: the labour commissioner route. If an employer wrongfully forfeits or delays gratuity, the employee can file a complaint with the controlling authority appointed under the Act (typically the regional labour commissioner or industrial tribunal). The controlling authority can order payment plus interest. If the authority's order is not followed, further recourse through the district court is available. The limitation period for filing a claim is one year from the date gratuity became due. Document all service history, exit communications, and any employer dispute notice; these are critical in a forfeiture dispute.

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 - it appears in the CTC breakdown on your salary slip as an employer cost line, separate from the deductions column.
• 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.

15. What to Do With Your Gratuity: The First 90 Days

Most guides tell you how gratuity is taxed. Almost none tell you what to do with the money after you receive it. The financial decisions in the 90 days after gratuity receipt have a bigger impact on your retirement than the tax computation itself.

Step 1: Determine the actual post-tax amount

Before spending or investing a rupee, calculate the exact post-tax gratuity in hand. If your total gratuity is ₹25L and ₹20L is exempt, the taxable ₹5L is added to your salary income in the retirement year. If your salary for the year (including the taxable gratuity) puts you in the 20% bracket, the net tax on the ₹5L gratuity is approximately ₹1.04L (with cess). You receive ₹25L gross, ₹1.04L goes to tax, leaving ₹23.96L net. Do this calculation first, ideally with your chartered accountant, before deciding investment amounts. Section 89 relief from Form 10E may further reduce the tax on the taxable portion.

Step 2: Allocate systematically , do not lump-sum invest in haste

The 90-day rule: do not make irreversible investment decisions in the first 90 days after retirement. Gratuity, combined with EPF and leave encashment, often arrives as a significant lump sum. The temptation to deploy it all immediately into a single instrument (real estate, FD, or a friend's business) is the biggest retirement financial mistake Indian retirees make. Instead: park the full amount in a liquid fund or sweep-in FD for the first 90 days while you plan properly.

The structured deployment framework for gratuity: After the 90-day stabilisation period, consider splitting the gratuity across three buckets. Bucket 1 (15-20%): 6-month emergency reserve in a high-interest savings account or liquid fund , liquid, accessible, zero lock-in. Bucket 2 (40-50%): guaranteed income layer in SCSS (up to ₹30L if eligible) or PPF top-up for tax-free compounding. Bucket 3 (30-35%): equity hybrid or balanced advantage mutual fund via SIP over 12-18 months (systematic investment of the lump sum reduces timing risk). This three-bucket structure from gratuity alone can form the foundation of a complete retirement income plan when combined with your EPF corpus, NPS annuity, and any pension income.

Step 3: Check whether the ₹20L exemption ceiling was fully used

If your gratuity at retirement is above the remaining exemption ceiling, the taxable portion needs special attention. Plan your ITR filing year carefully: if you retired in March, the gratuity appears in FY ending March (that year's ITR). If you retired in April, it falls in the next financial year , and you have 12 months to plan around it. File Form 10E before ITR, claim Section 89 relief, and consider whether the old vs new tax regime makes more sense in the retirement year given the gratuity spike. Use the tax regime comparison guide and the post-tax retirement income guide to model which regime minimises your total tax in the retirement year. Then build your post-retirement income plan using the Retirement Planning Calculator with the net-of-tax gratuity as the starting corpus.