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How To Calculate Gratuity And Tax Payable On It

Gratuity is the benefit paid by an employer to his employee... in gratitude for the services that s/he has offered... when s/he quits the job. The reason for separation could be anything such as retirement, job change, voluntary retirement or even retrenchment.

There is just one primary precondition... gratuity becomes payable only when the employee has completed at least 5 years of full-time service with a particular employer (except in cases of death or disability).

So, how do we calculate Gratuity receivable?
In simple terms, for each completed year of service you are eligible to receive half month's pay as gratuity. 

The formula to calculate gratuity, as laid down in the Payment of Gratuity Act, 1972, is pretty straightforward.

          Gratuity = (Monthly Salary / 26 x 15 days) x No. of years of completed service

- Salary includes last drawn Basic Pay + Dearness Allowance only; it excludes all other allowances and perquisites
- Years of completed service include full years + service of more than 6 months as 1 full year; service less than 6 months is not considered.

The gratuity payable to an employee should be paid within 30 days.

The employer has two options to manage the payment of gratuity. One is to pay it out of own funds as and when an employee leaves the company. Second, is to create a Group Gratuity Scheme with an insurance company. For this he pays a regular premium to an insurance company and it is then the insurer's responsibility to pay this gratuity amount whenever due.

Good News! Tax-free gratuity amount is now DOUBLED.

And, what is the income tax on Gratuity received? 
Gratuity received by Govt. Employees is totally exempt from tax.

For the Non-Govt employees
a) Gratuity received as per the prescribed formula is exempt from tax, subject to a maximum of Rs.10 lakhs Rs.20 lakhs. The amount has been doubled vide notification 'Payment of Gratuity (Amendment) Bill, 2018 passed by Parliament' dated Mar 22, 2018.

[Note : The above formula is for calculating the "tax-exempt" gratuity amount for the employees covered under the Gratuity Act. There is a small difference in the formula for those not covered under the said Act, as under:

               Gratuity = (Monthly Salary / 2) x No. of years of completed service

- Salary is last 10 months average of Basic Pay + Dearness Allowance; it excludes all other allowances and perquisites
- Years of completed service includes only the full years; service less than 1 year is not considered here.]

b) Amount received in excess of the aforesaid formula is taxable.

c) The limit of Rs.10 lakh Rs.20 lakh is not for a particular employer or for one particular year. All gratuity amounts received from all the employers put together, throughout your lifetime, will be tax exempt up to Rs.10 lakhs Rs.20 lakhs. As soon as you cross this limit, additional gratuity received becomes taxable.

Finally, this is how you should "ideally" use your gratuity amount...
This lump sum money is ideally useful in repaying any outstanding debt or invested for children’s education/marriage or buying a house. One should avoid splurging this money on wasteful whims and fancies.

[This post is an update of the earlier blog posted on Jan 28, 2015.]

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