Taxability of Gratuities Received By An Employee

Gratuity received from an employer forms part of salary income, but its taxability depends on the category of employment and the governing law. Death-cum-retirement gratuity paid by the Central or State Government, local authorities, and defence services is fully exempt under Section 10(10)(i). Gratuity received under the Payment of Gratuity Act, 1972 is exempt up to the lower of 15 days’ wages for every completed year of service (based on last drawn wages and counting service beyond six months as a full year) or ₹20,00,000. For private-sector employees not covered by the Act, exemption under Section 10(10)(iii) is limited to half-month average salary for each completed year of service, subject to the notified ceiling of ₹20,00,000. Any gratuity received beyond the limit becomes fully taxable as salary. Illustrations show how exemption is computed, demonstrating that exemption applies only up to statutory caps, with excess amounts taxed accordingly.

Under the head Salary, different types of benefits given to an employee, few of it is fully exempt, partly exempt and taxable. Let’s discuss one by one.

Gratuities:

There are different types of gratuities received by an employee at the time of retirement or death from employer.

(1) Death-cum retirement gratuity:

Death cum retirement gratuities received by the employees by the employers of the Central Government, State Governments, local authorities and members of Defense services are totally exempt from tax under Section 10(10)(i) of the Income Tax Act, 1961 and should not, therefore, be included in the salary income.

(2) Gratuity received under the Payment of Gratuity Act, 1972:

When an employee received any amount of gratuity in accordance

With the provisions of section 4(2) & (3) of the of Gratuity Act, 1972, is exempt as provided in section 10(10)(ii) of the Income tax Act, 1961. The amount of exemption of gratuity is to be calculated as under:

• According to section 4 of the Payment of Gratuity Act, 1972, gratuity is to be to an employee on the termination of his service, after he has rendered his service continues for not less than five years.
• Section 4(2) & (3)of the Payment of Gratuity Act, 1972 further state that the employer shall pay gratuity to an employee at the rate of 15 days’ wages for each completed year of service or part thereof in excess of six months on the basis of wages last drawn by an employee concern OR 20,00,000whichever is less.

As per section 2(s) of the Payment of Gratuity Act, 1972, the word

“Wages” is defined as under:

“Wages” includes all types of emoluments received by an employee while on duty or on leave in accordance with the terms and conditions of his employment, and which are paid or payable to him in cash and includes, dearness allowance, but does not include any bonus, commission, house rent allowance, overtime wages or any other allowance.

As per Income tax Act, exemption of gratuity amount is as under:

(a) for every completed year of service or part thereof in excess   of six months, based on the rate of wages last drawn by the employee concerned 15 day’s wages

OR

(b) the amount of the gratuity payable to an employee subject to a maximum of Rs.20,00,000

Whichever is less. 

ILLUSTRATION:

Mr. Shailesh Shah an employee completed 39 years and 8 months of service with S & company Ltd., and at the time of retirement he received Rs.18,00,000 as gratuity under the Payment of Gratuity Act,1972. He retired in the month of January, 2025. His monthly salary on the date of retirement was Rs. 78,000 per month. Calculate what is exemption amount of Gratuity?

ANSWER:

(a) The period of Service 39 years & 8 months

(b) As per Gratuity Act Completed years 40 years

(c) Wages drawn preceding retirement Rs. 78,000 p.m.

Wages per day 78,000/26 Rs. 3,000

Multiply each day’s wages by 15 Rs.3000×15=45,000

Multiply 15 days wages by 40  Rs.45,000x 40=18,00,000

For the assessment year 2025-26 the gratuity exempt will be Rs. 18,00,000 and received Rs. 18,00,000 hence nothing is to be added.

(3) Gratuity received by employees of private sector and statutory corporation:

Gratuity received on retirement, incapacitation, and death of the employee or termination of employment is exempt under section 10(10)(iii) of the Income tax Act, 1961 to the extent mention below:

Gratuity not exceeding ½ month salary for each year of completed service calculated on the basis of average salary of last 10 months in which any such event occurs, subject to such limit as may be notified by the Central Government ( at present such limit is of Rs.20,00,000)

Where gratuity is received by an employee from two or more employers in the same year, the maximum amount of gratuity exempt from tax shall not exceed Rs.20,00,000. In short whatever the amount and whenever it received if it exceed Rs.20,00,000 will be considered as salary income.

ILLUSTRATION:

Mr. Atul an employee completed 40 years of service with B & C0.Ltd. and at the time of retirement on 31^st March, 2025, he received Rs.30,00,000 as gratuity. His aggregate salary in the immediately preceding 10 months was Rs.15,00,000.

Calculate the amount of salary for assessment year 2025-26.

ANSWER:

Normally there is changes in exemption limit of gratuity every five to 6 years.