Gratuity is one of those things people only think about seriously when they're about to resign or retire — and by then, it's a bit late to understand how the number on your final settlement slip was actually arrived at. I've seen people assume HR just picked a figure, when it's actually a legally defined formula with very little room for discretion. Let me walk through exactly how it works.
Who is covered, and why it matters
The Payment of Gratuity Act, 1972 applies to any establishment with 10 or more employees — which covers the overwhelming majority of Indian companies. Whether your employer falls "under the Act" changes the formula used, so it's the first thing to check (your HR or appointment letter will usually confirm this, or you can check if your organisation has ever employed 10+ people).
The formula for employers covered under the Act
For most salaried employees, gratuity is calculated as:
Gratuity = (Last drawn Basic + DA) × 15/26 × Number of years of service
The 15/26 fraction represents 15 days of wages for every completed year, calculated using 26 working days a month (the Act assumes a 6-day work week with 4 Sundays off, hence 26 rather than 30). Only Basic salary plus Dearness Allowance counts — not your HRA, special allowance, bonus, or any other component.
Example: Priya's last drawn Basic + DA is ₹60,000/month, and she's completed 8 years at a company covered under the Act.
Gratuity = 60,000 × 15/26 × 8 = ₹2,76,923
The formula for employers NOT covered under the Act
If your employer isn't covered under the Payment of Gratuity Act (smaller establishments, or certain categories not notified under the Act), many employers still pay gratuity voluntarily or under their own policy — but typically using a different divisor:
Gratuity = (Last drawn Basic + DA) × 15/30 × Number of years of service
Here the calculation uses 30 days instead of 26, which works out to a slightly smaller gratuity amount for the same salary and tenure. Using the same example as above with the 15/30 formula: 60,000 × 15/30 × 8 = ₹2,40,000 — about ₹37,000 less than the Act-covered calculation.
The 5-year minimum — and when it doesn't apply
You generally need to complete a minimum of 5 years of continuous service with an employer to be eligible for gratuity. Resign at 4 years 11 months, and in most cases you get nothing — this trips up a surprising number of people who leave just short of the mark without realising it.
The exception: the 5-year requirement is waived if the employee's service ends due to death or disablement. In that case, gratuity is payable regardless of how long they'd worked.
How partial years get rounded
This is a detail people often get wrong. If your tenure includes a partial year, the rounding rule is: more than 6 months of service in the final year rounds UP to a full year; 6 months or less rounds DOWN.
So someone who worked 8 years and 7 months is treated as having completed 9 years for the gratuity calculation. Someone who worked 8 years and 5 months is treated as 8 years. That 2-month difference around the 6-month mark can noticeably change the final payout, so it's worth knowing exactly which side of it you're on before you plan your exit date.
Is gratuity taxable?
This depends on who you worked for:
Government employees (Central/State government, and certain categories of public sector employees) — gratuity received is fully exempt from tax, with no upper limit.
Private sector employees covered under the Payment of Gratuity Act — the exemption is the lowest of three amounts: (a) the actual gratuity received, (b) the amount calculated under the Act's formula above, or (c) a statutory cap. As of our last review, that cap stands at ₹20 lakh (raised from ₹10 lakh some years ago) — but tax-law ceilings like this do get revised periodically by government notification, so it's worth double-checking the current figure at the time you're actually calculating your tax, rather than assuming this article's number still holds years down the line.
Private sector employees NOT covered under the Act — a similar three-way lowest-of calculation applies, but using the 15/30 formula and a separate (generally lower, historically ₹10 lakh range) exemption ceiling — so employees in this category should specifically confirm their applicable cap rather than assuming it matches the Act-covered figure.
Whatever gratuity amount exceeds the applicable exemption limit gets added to your taxable income and taxed at your slab rate in the year you receive it.
A quick worked example, tax included
Take Priya again — ₹2,76,923 gratuity, covered under the Act. Since this is well below the ₹20 lakh exemption ceiling (and also below the formula-calculated amount, which in her case is the same figure), her entire gratuity is tax-free. Most salaried employees in India never actually cross the exemption threshold in their lifetime — it typically only becomes a live issue for people with very long tenures at a single employer combined with a high last-drawn salary.
Work out your own expected gratuity, with the correct 15/26 or 15/30 formula applied automatically, using our Gratuity Calculator.