Gratuity in Salary: Meaning, Calculation, & Taxation

Understanding your salary may appear to be simpler, but it is not. It includes many variables such as house rent allowance, conveyance allowance, contribution to employee provident fund, and so on. The most important of these is gratuity. It is a lump sum payment that can be extremely beneficial, particularly during retirement. Let us understand gratuity and its various aspects in depth.
 

What is Gratuity?

 
Gratuity refers to an employment benefit you receive from your employer in exchange for your services for a specific period. Gratuity benefits are available after five years of continuous service with the concerned organisation. The terms and conditions of the gratuity are as per the Payment of Gratuity Act, 1972. 
 
Primarily, the gratuity amount depends upon the service tenure and the last drawn salary. The last drawn salary means basic salary, dearness allowance (DA), and any commission you receive on meeting sales targets. 
 

Key Highlights from the Payment of Gratuity Act, 1972

 
The provisions of this act apply to employees of ports, mines, plantations, and any other organisation with more than ten employees.
 

Applicability	Government and private employees
Minimum service	Five years
Minimum employees	Ten
Tax exemption	Up to Rs 20,00,000
Gratuity payable	After resignation/ retirement/ death

 

How is Gratuity taxed?

 
Gratuity taxation depends on your employment type. You do not have to pay taxes if you work for the government, whether it is the state, the central, or a local government.
 
For non-government employees, the tax-exempt amount will be the least of the following.
 

• Rs 20,00,000
• The actual gratuity you received
• The eligible gratuity

 
Gratuity taxation example–
 
Suppose you receive a gratuity of Rs 14,00,000. However, based on past calculations, the gratuity you were earlier eligible for was Rs 4,00,000. 
 
Since the upper exempt limit is Rs 20,00,000, the tax-exempt amount, in this case, will be Rs 4,00,000, the lowest figure of all.
 
The taxable gratuity here will be Rs 10,00,000. (Rs 14,00,000 – Rs 4,00,000). The tax rate would be as per your income tax bracket.
 

How is Gratuity computed?

 
The gratuity computation method is different for various situations. The straightforward formula is detailed below.
 
Gratuity = [(N × B) × 15/26]
 
Where
"N" means the number of days you worked with any specific organisation
"B" means the last drawn salary
 
Now, let's pick each situation one by one.
 

1. Employees not covered under the Payment of Gratuity Act, 1972

   The gratuity computation is based on the half-month salary, which is 15 days. 
    
   Gratuity = (15 × L × P) ÷ 30
    
   Where
   "L" means the last basic salary
   'P' means the period of service 
    
   Suppose the period of your job is 11 years and 8 months. Your last basic salary is Rs 45,000. The gratuity will be–
    
   = (15 × 45,000 × 12) ÷ 30
   = (81,00,000 ÷ 30)
   = Rs 2,70,000
    
   Note: If the final service period exceeds six months of the last year, it will be rounded up to the following year. If it is less than six months, the lower year will be considered.
    

2. Gratuity in case of death

   The gratuity will be computed based on the number of years the deceased worked for the organisation.
    

   Service Tenure	Gratuity in Salary
   Less than a year	2 × Basic salary
   Between 1-5 years	6 × Basic salary
   Between 5-11 years	12 × Basic salary
   Between 11-20 years	20 × Basic salary
   Above 20 years	Half of the basic salary is computed considering every six months. The maximum limit here is 33 times.

    

What are some crucial Gratuity rules?

 

1. Gratuity forfeiture:

   Gratuity may be forfeited if the employee was terminated for misconduct or fraudulent behaviour.

2. Payment timelines for Gratuity

   The gratuity payment timelines depend upon the following factors.
    

   • Payment initiation

     As an employee, you must send a request letter to your employer to initiate the gratuity payment.
      

   • Acknowledgement

     After receiving your application, the appropriate person in your organisation will calculate the gratuity and notify you in writing.
      

   • Disbursement

     Payment must be processed within 30 days of the company sending the acknowledgement.
      

Also Read: EPF Advance vs. Personal Loan: Which is Better?
 

Final Words

 
Gratuity is an additional monetary benefit you receive for providing services for a set period. It is completely tax-exempt in the hands of government employees, but the exemption limit for private company employees is Rs 20,00,000.