For a private-sector employee covered by the gratuity law, the exempt gratuity is the least of: (1) 15/26 × last drawn basic + DA × completed years (part year over six months counts as a year), (2) ₹20,00,000, and (3) gratuity actually received. For employees not covered, it is the least of half a month's average salary (last 10 months) × completed years, ₹20,00,000 and the actual amount. Government employees' gratuity is fully exempt. Gratuity received while in service is fully taxable. The exemption applies in both tax regimes.
Worked example
Prakash retires from a private company after 12 years 7 months. Last drawn basic + DA ₹60,000 a month. Gratuity paid ₹4,50,000.
| Limit | Working | Amount |
|---|---|---|
| 1. Formula (covered) | ₹60,000 × 15 ÷ 26 × 13 years (7 months counts) | ₹4,50,000 |
| 2. Ceiling | ₹20,00,000 | |
| 3. Actual | ₹4,50,000 | |
| Exempt | Least of the three | ₹4,50,000 |
| Taxable | Nil |
If his employer paid ₹6,00,000 under a more generous policy, ₹1,50,000 would be taxable as salary and TDS would apply on it. Use the gratuity calculator for the entitlement.
Labour Codes and "wages"
The Payment of Gratuity Act, 1972 is now Chapter V of the Code on Social Security, 2020. The Labour Ministry's FAQs say gratuity uses the Code's definition of wages from 21 November 2025, so allowances above half of total pay are added back. That can raise the gratuity payable; the income-tax test still caps the exemption at ₹20,00,000 overall. Fixed-term employees are entitled to pro rata gratuity after one year under the Code.
Edge cases
- Two employers: the ₹20,00,000 limit is reduced by gratuity exempted in earlier years (section 19(2)(a)).
- Death: gratuity paid to legal heirs is not taxed as salary of the employee.
- TDS: deduct on the taxable part only, in the month of payment.
FundRaksha HR calculates gratuity on exit using the Code's wage definition and shows the exempt and taxable parts for TDS. See the full and final settlement format.
Sources
- www.incometaxindia.gov.in/w/section-19-206
- www.incometaxindia.gov.in/w/taxability-of-retirement-benefits
- www.incometaxindia.gov.in/w/section-536-2
- www.incometaxindia.gov.in/w/section-202-76
- www.labour.gov.in/static/uploads/2026/03/a4ccf4c6d97c4f1f36a6d83f8c64213d.pdf
- www.labour.gov.in/static/uploads/2025/07/b0620548445580767b5c0d18c95c26f7.pdf
Last reviewed: 2026-10-21. Information for Indian businesses; not legal advice.