The central government, under the 7th Pay Commission, has increased the gratuity limit for government employees along with various other allowances. This increase has led to many employees questioning how much tax they need to pay on their gratuity amount. Understanding gratuity taxation is essential for both government and private-sector employees.
What is Gratuity?
Gratuity is a lump sum amount paid by an employer to an employee as a token of appreciation for their service. It is usually given at the time of retirement, resignation, or in case of death or disability. Gratuity is governed by the Payment of Gratuity Act, 1972, which applies to both government and private-sector employees.
Gratuity Increased Limit for Government Employees
Under the 7th Pay Commission, the government has increased the gratuity limit for central government employees. As of January 1, 2024, the new gratuity limit is Rs 25 lakh, up from the previous limit of Rs 20 lakh. A circular was issued on May 30, 2023, confirming this change.
| Gratuity Limit | Before January 1, 2024 | After January 1, 2024 |
|---|---|---|
| Government Employees | Rs 20 lakh | Rs 25 lakh |
| Private Employees | Rs 20 lakh | Rs 20 lakh |
Is Gratuity Taxable?
Gratuity taxation rules differ for government and private-sector employees:
- Government Employees: The entire gratuity amount up to Rs 25 lakh is 100% tax-free. This applies whether the gratuity is received upon retirement, resignation, or even in the unfortunate case of death.
- Private Employees: The tax exemption limit on gratuity for private employees remains Rs 20 lakh. Any amount exceeding this limit is taxable as per the individual’s income tax slab.
| Employee Type | Tax-Exempt Gratuity Limit | Taxable Amount |
|---|---|---|
| Government Employees | Rs 25 lakh | No tax on gratuity received up to Rs 25 lakh |
| Private Employees | Rs 20 lakh | Any amount above Rs 20 lakh is taxable |
Tax Calculation on Gratuity for Private Employees
Private-sector employees can calculate their gratuity using the following formula:
Gratuity = (Last drawn salary × 15/26) × Number of years of service
Where:
- Last drawn salary includes basic salary + dearness allowance.
- 15/26 represents 15 days’ salary for each year worked.
- Number of years of service is rounded off to the nearest full year.
For example, if a private employee has a last drawn salary of Rs 1 lakh and has worked for 25 years, the gratuity calculation would be:
(1,00,000 × 15/26) × 25 = Rs 14,42,307
Since this amount is below Rs 20 lakh, it will be fully tax-exempt.
However, if the gratuity amount exceeds Rs 20 lakh, the excess amount will be taxed as per the individual’s income tax slab.
Gratuity Rules in Case of Death of an Employee
In case of the death of a government employee, their family receives gratuity up to Rs 25 lakh, which is fully tax-exempt. For private employees, the tax-exempt limit remains Rs 20 lakh.
| Scenario | Government Employees | Private Employees |
|---|---|---|
| Retirement | Tax-free up to Rs 25 lakh | Tax-free up to Rs 20 lakh |
| Resignation | Tax-free up to Rs 25 lakh | Tax-free up to Rs 20 lakh |
| Death | Tax-free up to Rs 25 lakh for the nominee | Tax-free up to Rs 20 lakh for the nominee |
Differences in Gratuity Rules for Government and Private Employees
| Feature | Government Employees | Private Employees |
|---|---|---|
| Maximum Gratuity Limit | Rs 25 lakh | Rs 20 lakh |
| Tax-Free Limit | Rs 25 lakh | Rs 20 lakh |
| Taxation on Excess Amount | No tax | Taxed as per income tax slab |
| Applicability of Payment of Gratuity Act | Not mandatory | Mandatory for companies with 10+ employees |
Ways to Reduce Tax on Gratuity (For Private Employees)
Private employees can take the following steps to minimize gratuity tax liability:
- Plan Retirement Timing: If possible, time your retirement in a financial year when your overall income is lower to stay in a lower tax bracket.
- Split Gratuity Payments: Request the employer to disburse gratuity in different financial years to reduce taxable income.
- Invest in Tax-Saving Instruments: Use excess gratuity funds to invest in tax-saving instruments like PPF, NPS, or tax-free bonds.
- Utilize Exemptions Under Section 10(10): Ensure gratuity exemption claims are properly filed under Income Tax Act Section 10(10).
FAQs
Is gratuity completely tax-free for government employees?
Yes, government employees do not pay any tax on gratuity received up to Rs 25 lakh.
How much gratuity is tax-exempt for private-sector employees?
Private employees get a tax exemption up to Rs 20 lakh. Any amount above this is taxable.
How is gratuity calculated for private-sector employees?
It is calculated as: (Last drawn salary × 15/26) × Number of years of service.
Can private employees receive gratuity above Rs 20 lakh?
Yes, but any excess amount will be subject to income tax.
Is gratuity taxable in case of death?
For government employees, gratuity up to Rs 25 lakh is tax-free. For private employees, up to Rs 20 lakh is tax-free.