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Gratuity calculation 2022: How tax exemption on gratuity payment is calculated

How is tax calculated on gratuity payments to employees? Gratuity tax calculation rules 2022: Salaried employees are entitled to gratuity payment as a part of their salary structure.

Gratuity calculation 2022: How tax exemption on gratuity payment is calculated
Gratuity is paid to salaried employees. Representative image

Gratuity tax calculation rules 2022: Salaried employees are entitled to gratuity payment as a part of their salary structure. Covered under the Payment of Gratuity Act 1972, Gratuity is a ‘Defined Benefit’ provided to employees as a lump sum on retirement. It is like a parting gift given to employees in recognition of services. 

An employee becomes eligible for gratuity payment after the completion of 5 years of continuous service in an organisation. As such, gratuity can be paid either at the time of retirement or termination or to the legal heir of the employee in case of his/her death. But 5-year continuous rule condition is not mandatory in case of the death of the employee.

Tax on Gratuity Payment

As per the income tax rules, gratuity received during employment is fully taxable in the hands of government as well as non-government employees, according to RSM India, an audit, tax and consulting services provider. 

“Gratuity, if any, received during the employment is fully taxable in the hands of employees, whether government and non-government. However, employees receiving death-cum-retirement gratuity can be classified in three categories. This segregation includes Government employees, employees covered by the Payment of Gratuity Act, 1972 and other employees,” RSM India said in a document shared with the FE PF Desk. 

However, there are some exemptions for different classes of employees: 

Government employee: Gratuity amount received by Central and State governments, local authorities and members of defence services is wholly exempt from tax. 

Employees covered under Payment of Gratuity Act: Tax exemption applies to the least of the following gratuity amount received: 

a. 15 days salary each completed year of service or part of the year in excess of 6 months, or

b. Rs. 20,00,000 or

c. Actual Gratuity received.

Salary for the purpose of clause (a) mentioned above includes the sum of Basic Salary and Dearness Allowance. The calculation is done by dividing the salary last down divided by 26 days ie. The maximum number of working days in a month.

Also Read: Gratuity Calculation Formula for Central Govt Employees 

Other employees not covered under Gratuity Act: The tax exemption for these employees applies on the least of the following: 

a. 1⁄2 month’s salary for each year of completed service, calculated on the basis of the average salary for the last 10 months or

b. Rs. 20,00,000 or

c. Actual Gratuity received.

Salary for the purpose of clause (a) mentioned above includes the sum of Basic Salary and Dearness Allowance (if provided) and commission as a percentage of turnover achieved by the employee. 

Tax on Gratuity Calculation: Example

Suppose an employee covered by the Payment of Gratuity Act 1972 has a monthly salary of Rs 31,2022. He retired on 30-5-2022 at the same salary and Rs 6 lakh as gratuity payment after completing 36 years and 9 months of services. The tax exemption for this employee will be calculated as follows: 

a.Completed years of service (rounded off)37 years
b.15 days’ wages – 15/26 × 31,200Rs. 18,000
c.The amount calculated at 15 days’ wages for 37 years (18,000 × 37)Rs. 6,66,000
d.Gratuity actually receivedRs. 6,00,000
e.Maximum limit applicable Rs. 20,00,000
f.Exemption allowable (least of c, d and e)Rs. 6,00,000
g.Taxable Gratuity (d – f)NIL
Calculated as per the provisions of the Payment of Gratuity Act 1972.

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