About Gratuity and How to Calculate Gratuity

Calculate Gratuity

Today we talk about About Gratuity and How to Calculate Gratuity. Gratuity is a total amount of money which a client or an employer pays to an employee for the services rendered to the company. Unlike provident fund, the employer pays the gratuity without any contribution from the employee. Gratuity is payable only to the employees who have completed 5 or more years with the company, under the Payment of Gratuity Act passed in the year 1972.

About Gratuity and How to Calculate Gratuity

Calculate Gratuity

Gratuity is payable only to the employees who have completed 5 or more years with the company, under the Payment of Gratuity Act passed in the year 1972. The Act covers employees engaged in mines, factories, oil fields, plantations, companies, and other establishments, where more than ten people are employed.

Gratuity is payable to an employee who has completed at least 5 or more years in a company and on the occurrence of any of the below events.

  • On death or disablement of an employee due to an accident or disease. Here, the limit of working at least 5 or more years with the company will not be applicable.
  • On retirement or resignation
  • Superannuation, i.e., when an employee reaches the age of retirement.
  • If this Act becomes applicable to an employer, the gratuity will be payable even if the number of employees goes down below 10.

Income Tax Exemption on Gratuity as per Income Tax Act

For a Government employee

If any employee of the Central Government, State Government or local authority, receives gratuity on death or retirement, it is entirely exempt from tax.

For a non-government employee where the employer is covered under the Payment of Gratuity Act

Here, the gratuity amount depends on the tenure of services and last drawn salary. The income tax exemption on gratuity is the least of the following:
-Rs. 20 Lakhs
-Actual gratuity received.
-15 days salary, based on the last drawn salary multiplied by the number of years of employment. (7 days salary for seasonal employees)

The following formula Calculate Gratuity:

Amount of Gratuity = Last drawn Salary × 15/26 × No. of Years of Service

For Example, an employee worked for 25 years in a company, and his last drawn salary was Rs. 60000. He received Rs. 10 lakhs as the gratuity.

Therefore, tax exemption on gratuity is the least of the following:
-Limit given by Government, i.e., Rs. 20 Lakhs
-Actual gratuity received, i.e., Rs. 10 Lakhs
-15 days salary based on the last drawn salary multiplied by the number of years in employment.
= 60000 × 15/26 × 25 = Rs. 8.65 Lakhs, i.e., least of all three

Therefore, Rs. 8.65 lakhs is exempt from tax calculation. So, an employee has to pay tax on Rs. 1.35 lakhs. (10 lakhs – 8.65 lakhs).

Notes: Here, salary will include basic salary as well as dearness allowance, if any. Service period will be rounded off to the nearest full year. For example, for the service period of 10 years and five months; it will be rounded off to 10 years and for the service period of 10 years and seven months; it will be rounded off to 11 years.

For a non-government employee where the employer is not covered under the Payment of Gratuity Act

The income tax exemption on gratuity is the least of the following:
-Rs. 10 Lakhs
-Actual gratuity received
-Half month’s average salary for every completed year of service (average salary of the 10 months immediately preceding the month of the employee’s retirement will be taken, and it will include basic salary and dearness allowance).

Amount of Gratuity = Average salary × 1/2 × No. of years of service

For Example, an employee worked for 25 years in a company and his average monthly of 10 months preceding the month of retirement was Rs. 60000. He received Rs. 10 lakhs as the gratuity.

Therefore, tax exemption on gratuity is the least of the following:
-Limit given by Government, i.e., Rs. 10 Lakhs
-Actual gratuity received, i.e., Rs. 10 Lakhs
-Half month’s average salary for each completed year of service
= 60000 × 1/2 × 25 = Rs. 7.50 lakhs

Therefore, Rs. 7.50 lakhs is exempt for tax calculation. So, an employee has to pay tax on Rs. 2.50 lakhs. (10 lakhs – 7.50 lakhs).

Notes: In the calculation of completed years, any fraction of a year shall be ignored. For example, if an employee has served for the period of 10 years and 10 months, Calculate Gratuity for 10 years.

An employer may pay a gratuity of more than Rs. 10 lakhs. He also has the right to reject payment of gratuity to the employee if an employee’s services have been terminated due to any misconduct. An employer can pay gratuity to the legal heir or nominee of the employee, in case of his death, which shall be taxed in the same manner as above but under the head “Income from Other Sources”. So, friend, I hope you understand About Gratuity and How to Calculate Gratuity in deeply.

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