Is Gratuity Taxable: Learn How to Do Gratuity Tax Calculation

Are you about to receive a gratuity? In that case, it is quite normal to wonder about the various tax implications on the gratuity amount.

In India, the tax calculations on gratuity depend upon multiple policies of the Income Tax Act of 1961. The tax charges are based on one’s type of employment and the circumstances that helped secure the job in the first place.

If you are still guessing "Is gratuity taxable?", then consider reading this blog. It will also provide you with practical strategies on how to grow your gratuity savings quickly and create a diversified portfolio with the best fixed deposits available online.

Taxability of Gratuity

Under the Income Tax Act, of 1961, when gratuity is given to an employee acknowledging their long service, that amount is totally taxable as the person’s regular income. On the other hand, if gratuity is offered upon resignation, retirement, death or other exceptional cases, then tax exemption applies as per Section 10(10) of the Income Tax Act. 

Private-sector employees, if covered under the Payment of Gratuity Act of 1972, can avail tax exemptions of up to ₹20 lakh for gratuity.

The sum received by a worker as a gratuity is considered as their income under the category ‘Income from Salary’. Nonetheless, if the employee meets an unfortunate death, the nominee or legal heir of the employee receives the amount. In this case, the same amount is assumed as ‘Income from Other Sources’. 

Is Gratuity Taxable Under New Tax Regime?

Non-government employees, under both old and new tax regimes, can exclude gratuity (up to ₹20 lakh) and leave encashment (up to ₹25 lakh) from their taxable income. This concessional tax regime, also popularly referred to as the new regime, was brought in Budget 2020. It enables taxpayers to enjoy low-income tax slab rates in return for surrendering many tax exemptions and deductions which were present in the old tax regime. 

What Is the Maximum Payable Amount as a Gratuity?

Hoping that the answer to the question, "Is gratuity taxable in India” is now clear to you, let us see if there is any upper limit fixed for this benefit.

The Gratuity Act declares a maximum sum that a person can get as gratuity, putting it at ₹10 lakh. Although this upper threshold is as per the laws, a company or organisation can decide to further increase the payout by terming the surplus component as a performance incentive or bonus. 

Eventually, the actual payout is based on a person’s salary and the number of years of service offered by them. 

Example Showing the Tax Calculation on Gratuity

Suppose, Mr XYZ retired from a private-sector company after working with the firm for 15 years. After retirement, he was provided with a gratuity amount of ₹12 lakh. While working, his last drawn salary was ₹45,000 which consisted of his basic salary along with dearness allowance. 

Now, as per the normal provisions, one can arrive at the tax exemption amount by following these steps:

Step 1: Note the actual gratuity received which is ₹12,00,000. 

Step 2: Calculate the exempt amount by using this formula:

Last drawn salary * 15/26 * Number of years of service

= ₹45,000 * 15/26 * 15

= ₹3,89,423

Here, the fraction 15/26 has been used to determine 15 days' salary for each year of service, considering 26 working days in a month, as per the standards of Indian labour laws.

As per current Income Tax Act rules, the maximum exemption limit is ₹20 lakh.

Step 3: Compare and determine the final exemption amount by comparing the actual gratuity received, the gratuity determined based on service and the maximum exemption limit. Here's how to do it:

• Actual gratuity paid by the company = ₹12,00,000
• Gratuity received based on years of service = ₹3,876,922.50
• Maximum exemption limit = ₹20,00,000

The least among the three figures is ₹3,89,423. Hence, this amount will be fully exempt from taxation. However, the rest of the amount, i.e., ₹(12,00,000 - 3,89,423) = ₹8,10,577 will be taxable as it comes under the category of “Income from Salary”. 

Suggestions to Boost Your Savings Beyond Gratuity

These 5 tips can help you meet your savings goals without causing significant stress:

1. Learn to Budget

Before budgeting, you must track your spending over a 30-day period. This will allow you to identify all variable costs that can help you put more towards your savings. 

1. Get Out of Debt

It is preferable to pay off or at least reduce your existing debts before you start managing savings and investments. To get out of loan installments quickly, you can follow the 50/30/20 budgeting principle, where you can set aside a specific amount from the 20% of your monthly income to pay towards loan repayments. 

1. Invest in Fixed-Income Instruments

You can earn up to 9.10% interest annually by investing in RBI-approved fixed deposits through Stable Money. Our app allows you to contribute to FDs of varying timeframes and thus you can manage goal-based investments with ease. 

1. Automate Your Savings

To follow this, you must set up an auto-transfer feature from your daily spending account. With Stable Money, you can effortlessly invest in high-return recurring deposits where a specific amount is sent to your investment account every month which helps to increase your retirement corpus. 

1. Cut Back on Your Utility Bills

Without many realising it, their electricity and gas bills consume a large part of their monthly fixed expenses. Therefore, with careful usage, it is possible to manage a bit of extra cash by the month's end that can go towards savings. 

Final Word

Employees need to have a solid understanding of "is gratuity taxable" as the amount is significant enough to affect their retirement goals. This guide aims to provide a clear response regarding the same, in accordance with the latest income tax rules. If you are looking to earn more beyond gratuity, consider FD options on the Stable Money app or consult a financial advisor for better financial planning.