How do we calculate the amount of gratuity exempted from tax?

Gratuity is a lump sum benefit given by employers to employees who have completed 5 or more years of service with the company and are retiring. The Payment of Gratuity Act, 1972 governs the calculation of gratuity, which is based on the last drawn salary and years of service. The gratuity amount is calculated as 4.81% of the basic pay. The Act applies to most firms with a workforce of 10 or more employees.

Is gratuity taxable? Yes, despite being different from the basic pay, gratuity is taxable. However, the government gives tax exemptions to gratuity amounts within a limit.

How is the amount of gratuity exempted from tax calculated?

The amount of gratuity exempted from tax = the last drawn salary x the number of years in employment x 15/26.

Last drawn salary = Basic Salary + DA (Dearness Allowance). The number of years in service is rounded off to the nearest full year.

Here is an illustration of tax exemption on gratuity:

Alex has been in employment for the past 19 years and 7 months. Their last drawn salary was Rs. 1 Lakh per month (Basic Salary + DA). Therefore, they are eligible for a gratuity payment of Rs. 11 Lakhs.

If an organization is not covered by the gratuity act, they can only receive a maximum tax exemption of ₹10 Lakhs.

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