How do we calculate the amount of gratuity exempted from tax?

Gratuity is a lump sum benefit given by employers to employees who have completed 5 or more years of service with the company and are retiring. The Payment of Gratuity Act, 1972 governs the calculation of gratuity, which is based on the last drawn salary and years of service. The gratuity amount is calculated as 4.81% of the basic pay. The Act applies to most firms with a workforce of 10 or more employees.

How is the amount of gratuity exempted from tax calculated?

The amount of gratuity exempted from tax = the last drawn salary x the number of years in employment x 15/26.

Here is an illustration of tax exemption on gratuity:

Alex has been in employment for the past 19 years and 7 months. Their last drawn salary was Rs. 1 Lakh per month (Basic Salary + DA). Therefore, they are eligible for a gratuity payment of Rs. 11 Lakhs.

Gratuity Exemption Comparison:

Sl. No	Particulars	Previously	As per Amendment
1	Last drawn salary (Basic + DA)	₹1,00,000	₹1,00,000
	Number of years of employment	20 (rounded off)	20 (rounded off)
	Gratuity amount (calculated)	₹1,00,000 * 20 * 15 / 26 = ₹11,53,846	₹1,00,000 * 20 * 15 / 26 = ₹11,53,846
2	Maximum exemption allowed	₹10,00,000	₹20,00,000
3	Gratuity actually received	₹11,00,000	₹11,00,000
4	Exemption amount	₹10,00,000	₹11,00,000
5	Taxable amount of gratuity	₹1,00,000	0

Conclusion:

Under the previous tax exemption rules, Alex's taxable gratuity amount would be ₹1,00,000 as the maximum exemption was ₹10,00,000. However, under the amended rules, Alex’s entire gratuity amount of ₹11,00,000 is exempt from tax, leaving no taxable amount.

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