What Is Gratuity Act? Eligibility, Calculation & Tax Implications
Gratuity is a financial gesture of gratitude from an employer to an employee for their long-term service and dedication to the organization. Governed by the Payment of Gratuity Act, 1972, it acts as a significant retirement benefit that provides a lump sum payment when you leave your job after several years. Think of it as a reward for your loyalty; the longer you stay with a company, the larger this thank you amount becomes. For the 2025-26 period, understanding these rules is more important than ever, as the government has maintained higher tax-free limits to ensure that your life savings remain protected when you decide to retire or move on to a new venture.
Who is Eligible for Gratuity?
Not every employee is automatically entitled to gratuity. There are two primary conditions that must be met:
- The 5-Year Rule: You must have completed at least five years of continuous service with the same employer.
- Organization Size: The Act applies to every factory, mine, oilfield, plantation, port, and railway company. For shops and other establishments, it applies if they have employed 10 or more people on any day in the preceding 12 months.
Exceptions to the 5-Year Rule
The five-year requirement is waived in two unfortunate circumstances:
- If an employee passes away while in service.
- If an employee becomes disabled due to an accident or disease.
In these cases, gratuity is paid to the employee or their nominee regardless of how many years they worked.
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How to Calculate Your Gratuity Amount
The formula for calculating gratuity depends on whether your company is covered under the Act or not. Most organized sector companies are covered.
1. For Employees Covered under the Act
The law uses a standard formula based on 15 days of your last drawn salary for every completed year of service.
Formula: Gratuity = (Last Drawn Salary × 15 × Years of Service) / 26
Salary Components: Includes Basic Pay + Dearness Allowance (DA). HRA and bonuses are excluded.
- The 26-Day Rule: Since there are usually four Sundays in a month, the law considers 26 working days for the calculation.
- Rounding Off Years: If you worked for 6 years and 7 months, it is counted as 7 years. If it is 6 years and 5 months, it is counted as 6 years.
2. For Employees NOT Covered under the Act
If your company is small and not covered, they can still pay gratuity voluntarily, but the formula changes slightly.
Formula: $\text{Gratuity} = \frac{(\text{Average Salary} \times 15 \times \text{Years of Service})}{30}$
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Tax Implications for 2025-2026
The tax treatment of gratuity is quite generous, especially after the recent updates to the exemption limits.
Category
Tax Treatment
Government Employees
Fully Tax-Free (No limit)
Private Sector Employees
Exempt up to ₹25 Lakh
Payment on Death
Fully Tax-Free for heirs
The ₹25 Lakh Limit
Following the latest reforms that remain active for the 2025-26 cycle, the tax-exempt limit for private employees is ₹25,00,000. If your calculated gratuity is ₹15 Lakh, you pay zero tax. If it is ₹30 Lakh, you pay tax only on the extra ₹5 Lakh based on your income tax slab.
Key Rules to Keep in Mind
- Timeline for Payment: The employer must pay the gratuity amount within 30 days of the employee leaving. If there is a delay, the employer may have to pay simple interest on the amount.
- Nomination: Every employee who has completed one year of service should fill out Form F to nominate a family member to receive the gratuity in case of the employee's death.
- Forfeiture: An employer can withhold or forfeit your gratuity only if your services were terminated for disorderly conduct, violence, or an act involving moral turpitude that caused financial loss to the company.
Explore more: Gratuity - Eligibility & How to calculate gratuity amount
Conclusion
The Gratuity Act serves as a vital safety net for the Indian workforce, rewarding long-term commitment with financial security. With the tax-free limit now at a high of ₹25 lakh for the 2025-26 period, it stands as one of the most tax-efficient ways to receive your terminal benefits. As an employee, the best strategy is to stay informed about your continuous service status and ensure your nomination details are updated in the company records. This small bit of planning ensures that your years of hard work translate into a substantial, tax-protected fund for your future.