Gratuity Rules 2025-26: Eligibility, Formula & Tax Limits

Gratuity is essentially a loyalty bonus that an employer pays an employee in recognition of long-term service. In the 2025-26 fiscal year, these rules have become even more significant as India transitions into new labour codes that redefine how wages are calculated for retirement benefits. For most employees, gratuity is a major part of their retirement nest egg, providing a lump sum amount at the time of exit. Whether you are resigning, retiring, or have completed five years of service, understanding the specific formula and the tax-free limits set by the government is the key to ensuring you receive every paisa you’ve earned through your hard work.

What is Gratuity? (The Rule of Loyalty)

At its core, gratuity is a defined benefit plan under the Payment of Gratuity Act, 1972. It is a lumpsum payment made by an employer as a token of appreciation for an employee’s stay in the organization.

Unlike your Provident Fund (PF), you do not contribute a single rupee from your monthly salary toward gratuity; it is 100% funded by the employer. However, it isn't an automatic right from Day 1. To unlock this benefit, you generally need to cross a specific milestone of continuous service.

Who is eligible for Gratuity in 2025-26?

Not every employee is entitled to gratuity. For the current 2025-26 period, the eligibility criteria are strictly defined:

• The 5-Year Rule: You must have completed at least 5 years of continuous service with the same employer.
• The 10-Employee Rule: The law applies to any organization (factories, mines, shops, offices) that has employed 10 or more people on any single day in the preceding 12 months.
• Continuous Service: This includes periods of leave, strikes, or layoffs that weren't the employee's fault.
• Exceptions for Death/Disability: The 5-year minimum service rule is waived if the employee passes away or becomes disabled due to an accident or disease. In these cases, gratuity is paid to the nominee or legal heir regardless of the tenure.

Note on Rounding: If you have worked for 4 years and 7 months (or anything above 6 months in your final year), the law often rounds it up to 5 years for eligibility purposes, though this can sometimes be subject to legal interpretation in specific courts.

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How Gratuity is calculated: The Formulas

The calculation depends on whether your company is Covered or Not Covered under the Payment of Gratuity Act.

A. For Employees Covered under the Act

Most private-sector employees in offices with 10+ people fall here. The formula assumes a 26-day working month (excluding Sundays).

$$Gratuity = \frac{15 \times \text{Last Drawn Salary} \times \text{Years of Service}}{26}$$

Key Components:

• Last Drawn Salary: This is your Basic + Dearness Allowance (DA) only. It does not include HRA, bonuses, or special allowances.
• Years of Service: Rounded to the nearest year. (e.g., 7 years 6 months = 8 years; 7 years 4 months = 7 years).

B. For Employees NOT covered under the Act

If your company has fewer than 10 employees, they can still choose to pay gratuity, but the formula changes. It uses a 30-day month and does not round up years.

$$Gratuity = \frac{15 \times \text{Average 10-Month Salary} \times \text{Completed Years of Service}}{30}$$

Gratuity Calculation Table: A Practical Comparison

Here is how the numbers look for an employee with a Basic + DA of ₹50,000 and 10 years of service:

Criteria

Covered under Act

NOT Covered under Act

Salary (Basic + DA)

₹50,000

₹50,000

Tenure

10 Years

10 Years

Calculation

(15 × 50,000 × 10) / 26

(15 × 50,000 × 10) / 30

Final Payout

₹2,88,461

₹2,50,000

Tax Implications for 2025-26

Gratuity is a tax-friendly benefit, but only up to a point. For the 2025-26 fiscal year, the tax treatment is as follows:

• Government Employees: Any gratuity received by Central/State government employees, local authorities, or defense personnel is 100% tax-free.

• Private Sector Employees: The tax-free limit is the least of the following:

  1. ₹20 Lakh (The statutory limit).
  2. The actual gratuity amount received.
  3. The amount calculated using the 15/26 formula.

Important Update: Any amount received above the ₹20 Lakh limit is added to your income and taxed according to your applicable income tax slab for the year. For Central Government employees, this limit has been increased to ₹25 Lakh effective from 2024-25.

Important Forms and Deadlines

Under the Payment of Gratuity Act, there are specific timelines that employers must follow:

• Application (Form I): An employee should ideally apply for gratuity within 30 days of it becoming due (resignation/retirement).
• Payment Window: The employer must pay the gratuity within 30 days of the date it becomes payable.
• Penalty for Delay: If the employer delays the payment beyond 30 days, they are liable to pay simple interest (usually around 10% per annum) on the delayed amount.
• Nomination (Form F): Every employee who has completed one year of service should fill out Form F to nominate someone to receive the gratuity in case of their death.

Conclusion

Gratuity is more than just a line item in your CTC; it is a financial reward for your dedication and time. For the 2025-26 period, the rules remain protective of the employee, ensuring that long-term loyalty results in a significant, tax-efficient payout. The most important things for you to remember are the 5-year eligibility mark, the ₹20 Lakh tax-free cap, and the fact that only your Basic + DA counts toward the calculation. By keeping an eye on your tenure and your salary structure, you can accurately plan your retirement finances and ensure your employer complies with the law.