What is gratuity? How is it calculated for income tax benefit?

Author: Reena More

Most of us know that a person is eligible to receive gratuity only if he/she has completed least five years of service with an organization. Gratuity is also considered as a benefit plan given by an employer to an employee. But, there are certain rules laid by the Government to claim this amount. Besides, a common man may not be aware of these rules. Although, as per the Payment of Gratuity Act, 1972, an employee is eligible to receive gratuity if he/she has rendered at least 5 years of continuous service with an employer. Since you receive a lump sum amount you can use that towards your child’s education, savings, and other financial purposes. This read will help you understand the benefits of gratuity and how it is calculated.

What is Gratuity?

Gratuity is a benefit given by the employer to an employer. Or in other words Gratuity is given to the employee by the employer and is usually paid at the time of retirement, but only if the provided conditions are met.

Eligibility

You are eligible to receive gratuity only if you have completed minimum of five years of service with an organization. However, in case, of the death of an employee or he/she becomes disabled due to accident or disease, it can be paid before completion of five years.

How is Gratuity calculated for Income tax purpose?

Gratuity amount is calculated as per section 10(10) of the Income Tax Act. Tax is exempted for Government employees and employees of the local authority. But such is not the case with non-government employees. Therefore, in order to calculate the amount of exemption in such cases, we shall understand the provisions that are stated in the Income Tax Act.

Note: As per the Income Tax Act, the lower of the following three amounts shall be exempted as gratuity in case of employees covered under the Gratuity Act.

  • Gratuity received
  • Your last drawn salary x 15/26 x completed years of service, where salary shall be basic+ dearness allowance and for the calculation of completed years of service part of the month above 6 months shall be accounted for.
  • The Maximum amount specified, i:e Rs. 20,00,000 (as per the Gratuity amendment bill.)

Let us see how the calculation of Gratuity with examples

Particulars

Example 1

Example 2

1.Completed year of service

30 Years

25 Years

2. Annual Income

10,00,000 (83,333 per month)

15,00,000 (1,25,000 per month)

3. Actual Gratuity Received

15,00,000 (Assumed)

18,00,000 (Assumed)

4. Calculation

i) 15,00,000

i) 18,00,000

ii) 83,333*15/26*30 = 14,42,302

ii) 125000*15/26*25 = 18,02,885

iii) 20,00,000

iii) 20,00,000

(Whichever is lower shall be selected)

(Whichever is lower shall be selected)

5. Exempted Gratuity

14,42,302

18,00,000

Things to remember for an employed individual with regards to Gratuity

  • Taxation

When an employee has completed his duration of service, then, in that case, the Gratuity is taxable and falls under the head of ‘salaries’. Besides, if the Gratuity is received at the time of his/her retirement death or superannuation there will be exemptions. But the exemption rules for government employees will be different and the ones for the private firm will be different.

  • Conditions on which Gratuity amount is paid

The Gratuity amount is paid on the following conditions:

  • On Resignation
  • On Death
  • Disablement due to accident or disease
  • Eligibility

An individual can avail gratuity if he/she has completed 5 years of continuous service in an organization.

Please note: In case of death or disability of the employee the amount will be paid to the legal heir.

  • Gratuity Benefits

In case you are planning to change your company before 5 years, it is vital that you do consider your decision as there is a possibility that you may lose huge amount which you are entitled to receive if you are in your 5th year of employment.

Conclusion:

Post the implementation of the 7th pay commission recommendations the changes required for private sector employees in respect of gratuity ceiling in the Payment of Gratuity Act, 1972 has been very well done. Also, Gratuity is now beneficial for both private as well as government sector employees. So, think twice before switching your company if you are almost nearing 5 years in an organization.