Gratuity: Rules, Formula and Income Tax Exemption (Tax Year 2026-27)
CA Meet Dhrangadhariya 
August 14, 2026
CA Meet Dhrangadhariya August 14, 2026
Table of Contents
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Last updated: 02 October 2026 · Written and reviewed by CA Meet Dhrangadhariya, CSM & Co LLP
Quick summary
Gratuity is a lump sum an employer pays for long service. Two questions come up every time: how much is payable, and how much of it escapes tax. This post answers both under the Code on Social Security, 2020 and the Income-tax Act, 2025.
The Code on Social Security, 2020 repealed the Payment of Gratuity Act, 1972 (section 164(1)). The four labour codes were made effective from 21 November 2025 (PIB press release), and the Ministry of Labour has said gratuity under the Code applies from that date. Notifications made under the old Act, such as the ceiling, are deemed to continue under the corresponding provisions of the Code (section 164(2)(a)). Gratuity is now in sections 53 to 56 of the Code. Older articles that quote the 1972 Act describe the same scheme, but the section numbers have changed.
Gratuity = Last drawn monthly wages ÷ 26 × 15 × completed years
Example: monthly wages ₹40,000, service 8 years: 40,000 ÷ 26 × 15 × 8 = ₹1,84,615.
Under section 2(88) of the Code, “wages” are basic pay, dearness allowance and retaining allowance, and if the excluded allowances (house rent allowance, conveyance and others) are more than half of total remuneration, the excess is added back to wages. The Ministry of Labour’s FAQs say performance incentives, ESOPs and reimbursements are not wages, and that gratuity and retrenchment compensation are left out of the 50% test. If your pay structure keeps basic pay low, the gratuity base may now be higher than under the old 1972 Act, from 21/11/2025. Ask your employer how the base is worked out.
Gratuity is part of salary (section 16(c) of the Income-tax Act, 2025). Section 19(1) then allows these deductions from it, in the order of the Table:
| Who receives it | Exempt amount |
|---|---|
| Death-cum-retirement gratuity under the Central Government pension rules or a similar government scheme (serial 3) | The entire amount |
| Retiring gratuity under the defence services pension code (serial 4) | The entire amount |
| Gratuity under the Payment of Gratuity Act, 1972, now the Code (serial 5) | The amount received, limited to the amount worked out under section 4(2) and (3) of that Act, which gives the 15/26 formula and the ₹20 lakh ceiling |
| Any other gratuity on retirement, incapacity before retirement or termination (serial 6) | The least of the actual gratuity, the notified amount (₹20 lakh) and half a month’s salary for each completed year |
“Salary” for these purposes is basic pay plus dearness allowance, if the terms of employment provide for it. All other allowances and perquisites are left out (section 19(2)(b)).
The exempt amount is the least of three figures:
Example: last drawn basic plus DA is ₹1,00,000 a month, service is 19 years and 7 months, so 20 years are counted. Gratuity paid is ₹15,00,000.
The exempt amount is the least of the gratuity received, ₹20 lakh and half a month’s salary for each completed year of service, where the salary is the average of the ten months before the month of the event (retirement, incapacity or termination). Only completed years count.
Example: average salary of the last ten months is ₹90,000, service is 25 years and 2 months, gratuity received is ₹14,00,000.
For serial 6, if you receive gratuity from more than one employer in a tax year, or received exempt gratuity in earlier years, the total exemption cannot exceed the notified limit reduced by what was already exempted (section 19(2)(a)). Keep a record of gratuity exempted in earlier jobs.
Of the section 19(1) Table, section 202(2) bars only serial number 1 (professional tax) in the new regime. The gratuity entries are not barred, so the gratuity exemption is available in both regimes.
| Point | Gratuity | Pension |
|---|---|---|
| Payment | One time, on leaving | Monthly, for life |
| Paid by | Employer | Employer, a pension fund or the government |
| Condition | Five years of continuous service (one for fixed-term) | As per the scheme |
| Tax | Exempt up to the limits above | Taxable as salary when received (commuted lump sum has separate rules) |
An employee who has completed continuous service of five years, on superannuation, retirement, resignation, death or disablement. Death and disablement do not need five years. A fixed-term employee is eligible after one year of service under the contract, with pro-rata gratuity.
Last drawn monthly wages ÷ 26 × 15 × completed years of service. A part year of more than six months counts as a full year.
For a government employee, the whole amount. For an employee covered by the gratuity law, the least of the gratuity received, the amount worked out by the statutory formula and the notified ceiling (₹20 lakh). For others, the least of the gratuity received, the notified ceiling and half a month’s average salary for each completed year.
Yes. Section 202(2) bars section 19(1) serial number 1 (professional tax) in the new regime, but not the gratuity entries at serial numbers 3 to 6.
Yes, to the extent it exceeds the exempt amount. It is part of salary (section 16), so the excess is taxed at your slab rate and TDS applies.
Only in the cases the law allows: wilful damage to the employer’s property, riotous or violent conduct, or an offence involving moral turpitude committed during employment. Forfeiture can be whole or partial.
This article is for general informational purposes only and should not be considered professional advice. Please consult a qualified expert for advice tailored to your specific situation. The author and website owner are not liable for any errors or actions based on this content.
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