Gratuity Meaning in a Salary: Eligibility, Calculation and Taxation Rules

When you have spent a significant amount of time in a company, you can naturally expect some form of return. Gratuity is one such example of how organisations reward their long-term employees. However, to qualify for gratuity, you must work in a company for 5 years or more. 

In India, the maximum gratuity amount one can receive is ₹20 lakh. During gratuity calculation, if the tenure in the final year exceeds 6 months, it is rounded up. Keep reading this blog to learn about the meaning and other related details.

Quick Synopsis 

• Gratuity is a statutory reward for employees completing 5 years’ service at a public or private company.
• The gratuity amount is calculated using a fixed formula depending on one’s service and salary.
• Gratuity payments are partly tax-free; death-related gratuity is fully exempt.

What is Gratuity? 

Gratuity is a financial bonus given to employees who have completed 5 years of continuous service with the same company. Companies pay this amount after an employee's resignation, retirement, or in the case of their unfortunate death or disability. 

The Payment of Gratuity Act, 1972, mandates gratuity payouts across factories, plantations, ports, mines, oilfields, shops and any establishment that has 10 or more employees. Additionally, this law outlines the rules for calculating a gratuity salary to prevent any disputes between the employer and the employee. 

Now that you understand the meaning of gratuity, let us find out who is eligible for this benefit. 

Who is Eligible for Gratuity Payment in India? 

Any employee must fulfil the conditions mentioned below to receive a gratuity payout from their company:

• Gratuity is paid upon superannuation. It means when an employee reaches a predetermined age, they get the pension as stated in their policy.
• Besides, if someone retires from work or resigns after serving 5 years uninterruptedly in a company, they are entitled to receive gratuity. 
• If the employee becomes disabled, then the clause regarding the minimum employment term (5 years) is ignored.
• Finally, if an employee dies due to an accident or serious illness, the specified nominee receives the gratuity amount, and the minimum employment term is ignored.

How to Calculate Gratuity? 

Although online gratuity calculators are available to help you determine your due gratuity, there is a formula for manual calculations as well. 

The formula to calculate gratuity for employees covered under the gratuity Act is as follows-

Gratuity = (n*b*15)/26

Here, n = tenure 

B = basic salary + dearness allowance 

15 denotes half-month compensation, and 26 is the number of working days in a month which excludes Sunday.

Here’s the formula for calculating gratuity for employees not covered under gratuity Act-

Gratuity = (15* Last recorded basic salary* Years of service)/30

Let us understand the calculation with a hypothetical example. 

Example-1- Rohan served 12 years in a company not covered under gratuity Act. While resigning, his last drawn salary was ₹35,000. In that case, his gratuity amount will be (15*35,000* 12)/30 = ₹2,10,000. 

Example 2- Swati served 8 years in a company covered under Gratuity Act. While resigning his last drawn salary was ₹50,000. In that case. His gratuity amount will be (8*50000*15)/26 =230769.231

Note that under the Payment of Gratuity Act, misconduct or violence by a candidate can lead to gratuity forfeiture.

Gratuity Calculation Upon Death of an Employee 

During a gratuity payout, a company considers only the employee's service tenure if they meet an unfortunate death. Once more, the upper limit is ₹20 lakh. You may take a look at the following table to get a brief idea:

Income Tax on Gratuity 

The amount of tax on gratuity salary varies depending on the living status of the recipient. For instance, any gratuity over ₹20 lakh is subject to taxation as per the applicable slab rate for the beneficiary. This is relevant since the sum is categorised as "Income from Salary." 

In the event of the death of an employee, the gratuity is provided to the listed nominee and is completely tax-exempt. Also, it will be considered as "Income from Other Sources" and not a part of the salary. 

Tax Exemptions on Gratuity

Before diving into the specific rules, it’s important to understand that gratuity tax exemptions vary based on the type of employment. The Income Tax Act treats government employees and private-sector employees differently when it comes to gratuity benefits. Here are some of the tax exemptions on gratuity.

Exemption to government employees:

Gratuity to government employees, termination, superannuation or retirement are fully exempt from tax. 

Exemption to Private-sector employees: 

Income tax exemption on gratuity to private-sector employees depends on whether the employee is covered under the Gratuity Act or not.

Exemption to employees not covered under the Gratuity Act

• Salary of last 10 months * completed service years * 15 / 26
• Salary includes last drawn basic salary + DA
• Rs 20 lakh exempt (hiked from Rs. 10 lakh)

Exemption to employees not covered under the Gratuity Act

• Salary of last 10 months * completed service years * 1/2
• Rs. 10 lakh exempt

Final Words 

Gratuity's meaning extends beyond a retirement benefit. It signifies recognition for dedicated service over a long term. 

Knowing the eligibility criteria, calculation rules, exemptions and tax treatments of gratuity equips employees with the knowledge to maximise their entitlements. By staying informed, one can ensure that this financial shield serves its purpose in improving post-employment security. Most importantly, it minimises disputes between the employer and employee.