How gratuity is calculated
Gratuity is a lump sum your employer pays for long service, and the formula depends on whether your company is covered by the Payment of Gratuity Act. The Act applies to any establishment with ten or more employees, so most people are covered. For a covered employee the payout is fifteen days of wages for every completed year, with a month counted as 26 working days — which gives the familiar 15/26 fraction of your last drawn basic plus dearness allowance.
For an employee not covered by the Act, the same fifteen days is divided by a full 30-day month instead, and part-years are ignored rather than rounded. Only basic pay and dearness allowance feed the formula; allowances such as HRA, bonus and overtime are excluded, so the payout tracks your core salary rather than your full package.
Worked example: ₹50,000 basic, 10 years
Take an employee leaving a covered company after ten full years with a last drawn basic plus DA of ₹50,000 a month. Fifteen days of wages work out to ₹50,000 × 15 ÷ 26, and multiplying by ten years gives the payout below. Because it sits well under the ₹20,00,000 ceiling, the whole amount is exempt from tax.
| Last drawn basic + DA | ₹50,000 |
| Completed years of service | 10 |
| Calculation | 15 ÷ 26 × ₹50,000 × 10 |
| Gratuity payable | ₹2,88,462 |
| Tax on this amount | Nil — within the ₹20,00,000 cap |
The five-year eligibility rule
Gratuity is earned only after five years of continuous service with the same employer, so an exit at four years and a few months normally carries no payout. There is one important exception: the five-year condition is waived if service ends because of death or disablement, in which case the employee or the family is paid for the actual service rendered.
The rule counts continuous service, and a widely followed reading treats 240 working days in the fifth year as a completed year, so four years plus 240 days can qualify. Beyond that point each additional year adds another fifteen days of wages to the payout, which is why a long unbroken tenure at one employer is rewarded so heavily.
The ₹20 lakh cap and how gratuity is taxed
There is a lifetime ceiling of ₹20,00,000 on tax-free gratuity for non-government employees, and it applies across your whole career: if you receive gratuity from more than one employer, the exemptions are added together against the same ₹20,00,000 limit. Government employees receive their gratuity fully exempt without this cap.
Anything above the exempt amount is added to your income and taxed at your slab rate, so a very large payout on a high salary can attract tax on the excess. For most employees, though, the figure the formula produces lands comfortably below ₹20,00,000 and reaches them in full. Your employer must pay the gratuity within 30 days of it becoming due, and a delay beyond that attracts simple interest.