Gratuity Calculation: Rules, Formula, Eligibility and Examples (2026)

Gratuity is a lump-sum payment made by an employer to an employee as a token of appreciation for continuous service. It is governed by the Payment of Gratuity Act, 1972, which applies to every factory, mine, oilfield, plantation, port, railway, shop, or establishment with 10 or more employees.

To be eligible for gratuity, an employee must have completed at least 5 years of continuous service with the same employer. The only exceptions to the 5-year rule are death or disablement of the employee, in which case gratuity is payable regardless of tenure. A key Supreme Court ruling (Surya India Pty Ltd, 2014) also clarified that service of 4 years and 240 days may qualify as 5 years in certain establishments.

Gratuity applies to all employees in covered establishments, whether permanent, temporary, or contractual (if on the company's rolls). Apprentices under the Apprentices Act are excluded. For employees not covered under the Act, many employers still pay gratuity as per company policy or employment contract.

The standard gratuity formula under Section 4(2) of the Payment of Gratuity Act is: Gratuity = (Last Drawn Salary × 15) ÷ 26 × Number of Completed Years of Service

Here, 'Last Drawn Salary' means Basic Pay + Dearness Allowance (DA). The 15 represents 15 days' wages, and 26 represents the number of working days in a month (excluding 4 Sundays). If the employee has served more than 6 months in the final year, it is rounded up to one full year.

For employees NOT covered under the Gratuity Act (e.g., some private firms with fewer than 10 employees), the formula changes slightly: Gratuity = (15 × Last Drawn Salary × Tenure) ÷ 30. Note that 30 (total calendar days) is used instead of 26.

For piece-rated employees, 'last drawn salary' is calculated as the average of total wages for the last 3 months preceding termination, excluding overtime.

Rahul worked at a manufacturing company for 8 years. His last drawn salary (Basic + DA) was ₹35,000 per month. Gratuity = (35,000 × 15 ÷ 26) × 8 = (5,25,000 ÷ 26) × 8 = 20,192.31 × 8 = ₹1,61,538

Since this amount is below the tax-exempt limit of ₹25 lakh, the entire gratuity of ₹1,61,538 is tax-free for Rahul. He receives this as a lump sum on leaving the company.

Priya worked at an IT company for 15 years and 7 months. Her last drawn salary (Basic + DA) was ₹80,000. Since she served more than 6 months in the 16th year, her tenure is rounded up to 16 years. Gratuity = (80,000 × 15 ÷ 26) × 16 = (12,00,000 ÷ 26) × 16 = 46,153.85 × 16 = ₹7,38,462

This is well within the ₹25 lakh exemption limit for private employees, so the entire amount is tax-free. For a government employee, the entire gratuity is exempt regardless of amount.

The tax treatment of gratuity depends on the type of employee: 1. Government employees (Central/State/Local authority): Entire gratuity received is fully exempt from income tax. No limit applies. 2. Private employees covered under the Gratuity Act: The least of the following three amounts is exempt: (a) Actual gratuity received (b) ₹25,00,000 (raised from ₹20 lakh w.e.f. 29 March 2018) (c) 15 days' salary for each completed year of service (calculated using the formula) 3. Private employees NOT covered under the Act: The least of: (a) Actual gratuity received (b) ₹25,00,000 (c) Half month's salary for each completed year of service

The ₹25 lakh limit is a lifetime limit across all employers. If you receive gratuity from multiple employers over your career, the total exemption cannot exceed ₹25 lakh. Any amount above the exempt limit is added to your taxable income and taxed at your slab rate.

For practical planning, use the gratuity calculator to estimate your amount, then check the tax impact with the income tax calculator. If your gratuity exceeds the exemption, plan for the tax outflow in advance.

The maximum tax-exempt gratuity was raised from ₹10 lakh to ₹20 lakh in 2018, and further to ₹25 lakh under the new labour codes (yet to be fully implemented as of 2026). However, many employers follow the ₹20 lakh cap under the current operative rules. Check the latest notification for the exact limit.

Under the proposed Code on Social Security, 2020, the eligibility period may change from 5 years to a shorter period, and the definition of 'wages' may be standardized. These changes are pending state-level implementation. Until then, the Payment of Gratuity Act, 1972 continues to apply.

Importantly, there is no cap on the actual gratuity amount an employer can pay. The cap only applies to the tax-exempt portion. Many companies, especially in IT and banking, pay gratuity significantly higher than the formula amount as per company policy. The excess over the exempt limit is simply taxable.

Can I get gratuity if I resign? Yes. Gratuity is payable on resignation, retirement, superannuation, death, or disablement, as long as you have completed 5 years of continuous service. Resignation does not disqualify you.

What if I was terminated? Even in case of termination (except for moral turpitude, violence, or offence involving moral turpitude), the employee is entitled to gratuity for the completed years of service.

Is gratuity part of CTC? Yes, most companies include gratuity as a component of Cost to Company (CTC). It is calculated as (Basic × 15/26 × estimated years). However, it is paid as a lump sum only when you leave the company after completing 5 years.

Can I nominate someone for gratuity? Yes. Every eligible employee must file a nomination (Form F) specifying who will receive the gratuity in case of the employee's death. The employer is required to obtain this nomination.

What is the time limit for paying gratuity? The employer must pay gratuity within 30 days of it becoming payable. If delayed, the employer must pay simple interest at the rate notified by the government.