Tax treatment of Gratuity income

Gratuity is a significant component of employee benefits in India, serving as a token of appreciation for an employee’s dedicated service. Whether you are an employer managing payroll or an employee curious about your entitlements, understanding gratuity is essential. In this blog post, we’ll explore everything you need to know about gratuity, including eligibility, calculation, tax implications, and its importance for financial planning. 

What is Gratuity?

Gratuity is a monetary benefit paid by employers to employees as a reward for their continuous service. Governed by the Payment of Gratuity Act, 1972, it is mandatory for organizations employing 10 or more employees. Gratuity is typically paid upon resignation, retirement, or death of an employee.

Eligibility for Gratuity

To qualify for gratuity, an employee must meet the following criteria:

1. Continuous Service: The employee must have completed at least five years of continuous service with the organization.
2. Exceptions: The five-year rule is waived in cases of death or disability caused by an accident or illness.

Tax Implications of Gratuity income

Gratuity serves as a valuable financial benefit for employees, but its tax treatment can vary based on the type of employment. Here’s a detailed breakdown of the tax implications of gratuity under the Income Tax Act, 1961:

1. For Government Employees

Gratuity received by government employees, including employees of state and central governments and local authorities, is completely tax-exempt under Section 10(10)(i) of the Income Tax Act.

2. For Non-Government Employees

The tax treatment of gratuity for non-government employees depends on whether the employer is covered under the Payment of Gratuity Act, 1972.

a. Employees Covered Under the Gratuity Act

For employees working in organizations covered under the Payment of Gratuity Act, the least of the following amounts is exempt from tax under Section 10(10)(ii):

1. Actual Gratuity Received
2. ₹20 lakhs 
3. 15/26 × Last Drawn Salary × Number of Completed Years of Service

Here, “salary” includes the basic pay and dearness allowance (if applicable).

b. Employees Not Covered Under the Gratuity Act

For employees working in organizations not covered under the Gratuity Act, the least of the following amounts is tax-exempt under Section 10(10)(iii):

1. Actual Gratuity Received
2. ₹20 lakhs 
3. ½ × Average Salary × Number of Completed Years of Service

In this case, “salary” is the average of the basic pay and dearness allowance for the last 10 months of service.

3. Taxable Gratuity

Any gratuity amount received above the exempted limits is taxable as part of the recipient’s income under the head ‘Salaries’ and is subject to income tax as per applicable slab rates.

What is Tax-Free Limit of ₹20 Lakhs?

The tax-free limit of ₹20 lakhs applies cumulatively across an individual’s lifetime. If an employee receives gratuity from multiple employers, the aggregate amount exempted from tax cannot exceed ₹20 lakhs.

Gratuity in Case of Death

If gratuity is paid to the legal heirs of a deceased employee, it is fully tax-exempt, regardless of the amount, under Section 10(10) of the Income Tax Act.

ITR Filing for Gratuity

Employees must declare taxable gratuity in their income tax returns under the “Salaries” head. Employers are responsible for deducting Tax Deducted at Source (TDS) on taxable gratuity exceeding the exempted limit.

Conclusion

Gratuity is more than just a legal obligation; it reflects an organization’s commitment to its workforce. For employees, it’s a vital financial benefit that can help secure your future. Stay informed about gratuity rules, ensure compliance, and leverage its advantages for better financial planning.

Need help with gratuity calculation or compliance? Contact our CA experts for tailored solutions!