Gratuity exemption under Section 10(10) of the Income Tax Act, 1961 makes the entire gratuity payment tax-free for government employees, and gives private-sector employees an exemption capped at ₹20 lakhs, calculated through a formula that depends on your salary, your years of service, and whether your employer is covered under the Payment of Gratuity Act, 1972. Anything above the exempt amount is taxed as salary income in the year you receive it.
Which Category You Fall Into
Section 10(10) splits employees into three groups, and the group decides the rule.1Indian Kanoon. Income Tax Act 1961 – Section 10
- If you work for the Central Government, a State Government, a local authority, or hold a defense-connected post, Section 10(10)(i) exempts your entire gratuity. There is no formula and no cap.
- If your employer is covered under the Payment of Gratuity Act, Section 10(10)(ii) applies. Your exemption is the lowest of a formula amount, the actual gratuity received, and ₹20 lakhs.
- If your employer pays gratuity but is not covered under the Act, Section 10(10)(iii) applies, with a different formula and the same ₹20 lakh ceiling.
Getting the category right matters because the salary definition, the formula, and the way years are counted all change with it.
What “Salary” Means for the Calculation
For employees covered under the Payment of Gratuity Act, salary means basic pay plus dearness allowance only, and the relevant figure is your last drawn monthly pay. Nothing else in your payslip counts.
For employees not covered under the Act, salary means basic pay, dearness allowance, and any commission earned as a fixed percentage of turnover. The relevant figure is your average monthly salary over the ten months immediately before the month your employment ends.1Indian Kanoon. Income Tax Act 1961 – Section 10
The distinction has real consequences. A recent raise pushes up the last-drawn figure but barely moves the ten-month average, so two employees with identical pay histories can see different exempt amounts purely because of which formula their employer falls under.
Formula If Your Employer Is Covered Under the Act
The exempt amount is the lowest of these three values:
- Last drawn monthly salary ÷ 26 × 15 × completed years of service
- ₹20 lakhs
- The actual gratuity received
Dividing by 26 converts monthly pay into a daily rate based on working days, and multiplying by 15 gives you fifteen days of wages per year served.2India Code. Payment of Gratuity Act 1972 – Section 4
Fractional years round up when the extra period exceeds six months. So 12 years and 7 months is treated as 13; 12 years and 4 months stays at 12.2India Code. Payment of Gratuity Act 1972 – Section 4
Worked Example
Say your last drawn monthly salary (basic plus dearness allowance) is ₹80,000 and you served 15 years. The formula produces ₹80,000 ÷ 26 × 15 × 15, which is roughly ₹6,92,308. If your employer pays ₹8,00,000, that formula figure is the lowest of the three, so ₹6,92,308 is exempt and the remaining ₹1,07,692 is taxable salary.
Change one variable. Same salary, 30 years of service, and a payout of ₹22,00,000. The formula now gives ₹13,84,615, but the ₹20 lakh statutory cap is lower still and becomes the exempt amount. The taxable portion is ₹2,00,000.
Formula If Your Employer Is Not Covered Under the Act
Again the exempt amount is the lowest of three figures, but the formula shifts:
- Average monthly salary over the last ten months × completed years of service × ½
- ₹20 lakhs
- The actual gratuity received
Here, fractions of a year are ignored rather than rounded. Fourteen years and eight months counts as 14. And “salary” for this formula includes any commission received as a fixed percentage of turnover, alongside basic pay and dearness allowance.1Indian Kanoon. Income Tax Act 1961 – Section 10
The ₹20 Lakh Cap Is Cumulative Across Your Career
The ceiling was raised to ₹20 lakhs by government notification in 2018 for Act-covered employees and in 2019 for other private-sector employees, replacing the earlier ₹10 lakh limit.3Income Tax India. Enhancement of Gratuity Exemption Limit Under Section 10(10)
The ₹20 lakh limit is a lifetime figure, not a per-employer figure. If you claimed ₹8 lakhs of exemption on gratuity from an earlier employer, only ₹12 lakhs of exemption is available across all future employers combined. The statute reduces the current exemption by any gratuity received in earlier years that was not included in total income, and CBDT Circular No. 573 dated 21 August 1990 states the position expressly.1Indian Kanoon. Income Tax Act 1961 – Section 10
Keep records. Your Form 16 from each employer should show the exempt portion, and those documents are what you need if the department queries a later claim. Overclaiming triggers a notice; underclaiming means paying tax you did not owe.
Gratuity Exemption Survives the New Tax Regime
The new tax regime under Section 115BAC removes most exemptions and deductions, but Section 10(10) is one of the survivors. The exemption rules for gratuity are identical whether you opt for the old regime or the new one.
Reporting Gratuity on Your Return
Section 17(1) treats gratuity as part of salary, so it is reported under the “Income from Salaries” head, with the exempt portion claimed separately.4Indian Kanoon. Income Tax Act 1961 – Section 17 Salaried individuals typically use ITR-1 (Sahaj) or ITR-2 depending on their total income and other sources.
The financial year in which you actually receive the payment is the year you report it. If you resign in March but the money arrives in April, it belongs in the following year’s return. Your employer’s Form 16 should already split the exempt and taxable portions, but check the split against your own calculation before you file. Errors happen, particularly where HR applies the wrong category formula.
If you have received gratuity from more than one employer over your career, add up the exemptions claimed and confirm the running total stays within ₹20 lakhs. The department can cross-reference Form 16 filings from multiple employers, and a lifetime overclaim is one of the simpler discrepancies for it to identify.