Gratuity Tax Exemption 2026: Formula and How to Report in ITR
Gratuity tax exemption in India allows private sector employees to receive up to Rs. 20 lakh completely tax-free. If you are retiring, resigning after five or more years, or simply planning ahead, gratuity is one of the most tax-efficient components. For most private sector employees, up to Rs. 20 lakh of gratuity is completely exempt from income tax. Government employees get an even better deal: their entire gratuity is tax-free with no upper limit.
This guide covers the exact exemption limits, how the tax-free amount is calculated, what changed under the new Income Tax Act 2025, and how to correctly report gratuity in your ITR so you do not get a notice for under-disclosure.
What Is Gratuity?
Gratuity is a lump sum payment made by your employer as recognition for your long-term service. It is governed by the Code on Social Security, 2020 (which consolidated the earlier Payment of Gratuity Act, 1972, effective November 2025). Unlike EPF or NPS, you contribute nothing toward gratuity from your salary. It is 100% funded by your employer.
Gratuity becomes payable when you leave the organisation due to:
- Retirement or superannuation
- Resignation after completing minimum service period
- Death or permanent disablement (five-year rule waived in these cases)
- Termination (except for proven gross misconduct)
Eligibility: Who Qualifies for Gratuity?
To be eligible, you must meet both conditions below:
- Five years of continuous service with the same employer (exception: death or disablement)
- The organisation has 10 or more employees on any single day in the preceding 12 months
2026 update for fixed-term employees: Under the Code on Social Security, fixed-term employees (those on contracts with a defined end date) became eligible for gratuity after completing just one year of continuous service, effective November 2025. This is a significant change if you are on a contractual arrangement.
Gratuity Tax Exemption Limits: The Three Categories
The Income Tax Act treats gratuity differently based on the type of employment. There are three distinct categories under Section 10(10) of the Income Tax Act 1961 (continuing under the Income Tax Act 2025):
| Category | Employee Type | Tax Exemption |
|---|---|---|
| Category 1 | Central/State Government, Defence, Local Authority employees | Fully exempt, no monetary cap |
| Category 2 | Private sector employees covered under Payment of Gratuity Act | Least of three amounts, capped at Rs. 20 lakh |
| Category 3 | Private sector employees NOT covered under Payment of Gratuity Act | Least of three amounts (different formula), capped at Rs. 20 lakh |
Note for Central Government employees: The maximum gratuity payable to central government employees was increased to Rs. 25 lakh effective January 1, 2024. Since government employees have no monetary cap on the exemption, the entire Rs. 25 lakh is tax-free.
Category 2: Private Sector (Covered Under Payment of Gratuity Act)
This applies to most private sector employees working in organisations with 10 or more employees. The tax-exempt amount is the lowest of the following three figures:
- A. Actual gratuity received
- B. Rs. 20,00,000 (the statutory ceiling)
- C. 15 days’ salary for each completed year of service, calculated as: (Last drawn Basic + DA) × 15 / 26 × Years of service
The 26 in the formula represents working days in a month. The 15 represents 15 days’ pay. Only Basic Pay and Dearness Allowance (DA) count as salary for this formula. HRA, bonus, and other allowances are excluded.
Worked Example: Category 2
Priya has worked at a private company for 18 years. Her last drawn Basic + DA is Rs. 80,000 per month. Her employer pays her Rs. 83,000 as gratuity.
- A. Actual gratuity = Rs. 83,000
- B. Statutory ceiling = Rs. 20,00,000
- C. Formula = Rs. 80,000 × 15 / 26 × 18 = Rs. 83,076
The lowest is Rs. 83,000 (actual gratuity received). The entire Rs. 83,000 is tax-free.
Now consider Rajan, who retires after 30 years with a Basic + DA of Rs. 1,50,000 per month and receives Rs. 26,00,000 as gratuity:
- A. Actual gratuity = Rs. 26,00,000
- B. Statutory ceiling = Rs. 20,00,000
- C. Formula = Rs. 1,50,000 × 15 / 26 × 30 = Rs. 25,96,153
The lowest is Rs. 20,00,000 (statutory ceiling). Rajan’s tax-free gratuity is Rs. 20 lakh. The remaining Rs. 6 lakh is added to his income from salary and taxed at his applicable slab rate.
Category 3: Private Sector (NOT Covered Under Payment of Gratuity Act)
This applies to employees in organisations with fewer than 10 employees, or organisations that are otherwise outside the Act’s coverage. The tax-exempt amount is the lowest of the following three figures:
- A. Actual gratuity received
- B. Rs. 20,00,000 (same statutory ceiling applies)
- C. Half month’s average salary for each completed year of service, calculated as: (Average salary of last 10 months × ½ × Years of service)
For Category 3, average salary includes Basic Pay, DA, and commission based on a fixed percentage of turnover. The averaging is done over the last 10 months before leaving, not just the last month’s salary.
Gratuity Tax Rules Under the New Tax Regime
This is the part most articles do not cover clearly. Under the new tax regime (Section 115BAC), most exemptions were removed. Gratuity exemption was partially affected:
- The full Rs. 20 lakh exemption is available under the old tax regime
- Under the new tax regime, CBDT Circular No. 06/2025 (May 2025) clarified that gratuity up to Rs. 5 lakh is exempt for retirement, resignation, or death-related gratuity
Practical implication: If your total gratuity is below Rs. 5 lakh, the new regime does not disadvantage you. If your gratuity is significantly above Rs. 5 lakh, the old regime’s Rs. 20 lakh ceiling is far more beneficial and should be a key factor in your tax regime decision for the year of retirement or resignation.
For most salaried professionals nearing retirement with significant gratuity amounts, the old regime will almost always save more tax. Use the income tax slabs guide to calculate both scenarios before deciding.
Gratuity Under the New Income Tax Act 2025
The Income Tax Act 2025, effective from April 1, 2026, renumbers sections but does not change the gratuity exemption rules. The Rs. 20 lakh ceiling, the three-category structure, and the formulas all continue as they were under Section 10(10) of the 1961 Act.
Important for your July 2026 ITR filing: Your return for FY 2025-26 is governed by the Income Tax Act 1961. Use old section references (Section 10(10)) when reporting gratuity exemption. New section numbers apply from Tax Year 2026-27 returns filed in July 2027 onwards. For a full comparison of what changed and what stayed the same, read the Income Tax Act 2025 vs 1961 guide.
Special Situations
Gratuity Received from Multiple Employers
If you receive gratuity from more than one employer in the same financial year (for example, after changing jobs twice and meeting the five-year threshold at both), the total exemption across all employers cannot exceed Rs. 20 lakh. Each employer calculates the exempt amount using the formula, but the combined exemption is capped at Rs. 20 lakh for the year.
Gratuity on Death or Disablement
If gratuity is paid due to the employee’s death or permanent disablement, the five-year service requirement is waived. The gratuity received by the nominee or legal heir in case of death is fully exempt from income tax with no monetary cap, regardless of the employment category.
Employer Pays More Than Statutory Limit
Some employers, especially large corporates and PSUs, pay gratuity above the statutory entitlement as an ex-gratia benefit. The statutory limit still applies for tax purposes. Any amount received above Rs. 20 lakh (or above the formula amount if lower) is taxable as salary income in the year of receipt.
How to Report Gratuity in Your ITR
Many people receive gratuity and either forget to report it or report it incorrectly. Both can lead to notices. Here is the correct approach:
- Step 1:Â Identify the total gratuity received during the financial year
- Step 2:Â Calculate the exempt portion using the applicable formula (Category 1, 2, or 3)
- Step 3: In ITR-1 or ITR-2, report the gross gratuity under “Income from Salaries”
- Step 4: Report the exempt portion under “Exempt Income” (Schedule EI or the salary schedule, depending on your ITR type)
- Step 5:Â Only the taxable portion (if any, above Rs. 20 lakh) gets added to your taxable income
Do not skip reporting the exempt portion. The Income Tax Department receives information about gratuity payments from employers through TDS returns and Form 16. If your ITR does not show the gratuity at all, it can trigger a mismatch notice even if the amount was fully exempt. Always verify that the gratuity figures in your Form 26AS and AIS match what you report in the ITR.
Section 89 Relief: If Gratuity Pushes You Into a Higher Slab
If your taxable gratuity (the portion above Rs. 20 lakh) is large enough to push you into a higher tax slab in the year of receipt, you can claim relief under Section 89 of the Income Tax Act. This relief spreads the tax burden across the years of service, reducing the tax impact significantly.
To claim Section 89 relief, you need to file Form 10E on the income tax portal before filing your ITR. The relief is calculated by comparing tax with and without the lump sum, averaged over the years of past service. If you have a large taxable gratuity amount, consult a CA to calculate and file Form 10E correctly before the July 31 deadline. For ITR filing deadlines and the consequences of missing them, read the ITR filing last date 2026 guide.
Key Points to Remember
- Government employees: fully exempt, no cap
- Private sector (covered under Act): exempt up to Rs. 20 lakh, formula is 15/26
- Private sector (not covered): exempt up to Rs. 20 lakh, formula uses half-month average of last 10 months
- New tax regime: only Rs. 5 lakh exempt (per CBDT Circular 06/2025). Old regime gives full Rs. 20 lakh benefit
- Multiple employers in same year: combined cap of Rs. 20 lakh across all gratuity received
- Always report both gross gratuity and exempt portion in ITR, even if fully tax-free
- Taxable portion (above Rs. 20 lakh): consider Section 89 relief to avoid higher slab impact
The exemption limits are notified by the Income Tax Department – you can verify the latest threshold limits on the official Income Tax India website.
Frequently Asked Questions
Is gratuity taxable if I receive it before completing five years?
Yes. If you leave before five years (and it is not due to death or disablement), any amount paid by the employer is treated as ex-gratia, not statutory gratuity, and is fully taxable as salary income. The Section 10(10) exemption does not apply.
What if my employer does not fall under the Payment of Gratuity Act?
You fall under Category 3. The exemption formula uses half-month average salary (basic + DA + fixed commission) for each completed year, averaged over the last 10 months. The Rs. 20 lakh ceiling still applies.
Can I claim Section 80C or any other deduction to offset taxable gratuity?
Yes, under the old regime. If your gratuity is partially taxable and you have available Section 80C investments, HRA, or home loan interest deductions, these can reduce your overall taxable income. Under the new regime, these deductions are not available, which is another reason to consider the old regime carefully in your year of retirement. Read the Section 80C deductions guide for a complete list of what you can claim.
Is the gratuity received by family on employee’s death taxable?
No. Gratuity received by the nominee or legal heir of a deceased employee is fully exempt from income tax with no upper limit, regardless of employment category.
My Form 16 shows gratuity as part of salary. Is that correct?
Yes, employers include gross gratuity in the salary figure and then show the exempt portion separately. When you file your ITR, match the figures with your Form 16. The net effect should be that only the taxable portion (if any) affects your tax liability. If you see any discrepancy, check your AIS and Form 26AS before filing.
Have questions about your specific gratuity situation? Drop them in the comments below.
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