Gratuity Tax Exemption: How the ₹20 Lakh Limit Actually Works (With Worked Examples)

Sunita retired in September after 23 years with the same company, on a last drawn salary of ₹80,000 a month. Her employer paid her ₹18,00,000 as gratuity. She had read that gratuity is tax-free up to ₹20 lakh, so she expected no tax at all. Her Form 16 told a different story: ₹7,38,462 was taxable. The ₹20 lakh figure is a ceiling, not a promise — the exemption is the least of three amounts, and in her case the formula amount was the smallest. For the full picture on salary exemptions, keep the deductions and exemptions hub open.

The rule in one paragraph

Gratuity is the lump sum an employer pays for long service, governed by the Payment of Gratuity Act, 1972, which applies to establishments with 10 or more employees. The tax exemption comes from Section 10(10) of the Income-tax Act, 1961 — carried forward unchanged as Section 19 read with Schedule II of the Income-tax Act, 2025, which applies from 1 April 2026. Government employees — Central, State or local authority — get the whole amount exempt, with no limit. Everyone else gets the least of three amounts, capped at ₹20,00,000 over their whole career. The ceiling was raised from ₹10 lakh by CBDT Notification No. 16/2019 (S.O. 1213(E)) dated 8 March 2019, for employees who retired, died, resigned or became disabled on or after 29 March 2018 — and it has not changed since.

The three-way test — and the two different formulas

For a private-sector employee, the exempt amount is the lowest of (a) the actual gratuity received, (b) ₹20,00,000, and (c) the formula amount. The formula is where most people go wrong, because it differs depending on whether your employer is covered by the Payment of Gratuity Act:

The 15/26 formula has a logic: 15 stands for 15 days’ wages per year of service, and 26 is the working days in a month. The not-covered formula works out to 15/30 of the 10-month average salary per year — smaller, because the salary base is an average rather than the last drawn pay. With 10 or more employees, you are almost certainly covered; the not-covered formula bites mainly in small establishments that pay gratuity voluntarily.

Worked example 1: covered by the Act — Sunita’s case

Sunita’s last drawn salary (basic plus DA) was ₹80,000 a month, and she completed 23 years of service. Her employer paid ₹18,00,000.

The formula, not the ₹20 lakh ceiling, decided her answer — the usual outcome when salary is modest relative to the payout. With the same 23 years but a last drawn salary of ₹1,50,000, the formula gives ₹19,90,385, and the exemption is ₹19,90,385 against a ₹20,00,000 ceiling. The exemption tracks salary history, not the cheque size.

Worked example 2: not covered by the Act

Arvind worked 18 years for a small firm with fewer than 10 employees, which paid gratuity voluntarily. His average salary over the last 10 months was ₹90,000, and he received ₹12,00,000. His formula amount is half a month’s average salary — ₹45,000 — times 18 years, which is ₹8,10,000. The least of the three is ₹8,10,000, so ₹3,90,000 is taxable as salary. Note the difference from the covered formula: no rounding up of a part-year, and the salary base is a 10-month average — both work against the employee, so confirm the covered/not-covered question with HR before you file.

Five traps that cost real money

1. The ₹20 lakh cap is once in your career, not once per employer. If you claimed ₹8,00,000 at Company A, your remaining ceiling at Company B is ₹12,00,000. The new employer will not know what you claimed — you have to track it, and the figure sits in your old Form 16s.

2. You need five years of continuous service. Under the Payment of Gratuity Act, gratuity is payable only after five years with the same employer. Leave before that and there is usually no gratuity at all — and no exemption to claim. The five-year condition does not apply when gratuity is paid on death or disablement.

3. Gratuity received while still in service is fully taxable. The exemption applies on retirement, resignation, death or disablement — not mid-employment. If your employer offers an interim payout, the whole amount is salary income.

4. The new regime does not kill this exemption. Gratuity under Section 10(10) is an exemption, not a Chapter VI-A deduction, so it survives the new regime exactly as it survives the old one — as does leave encashment at retirement (our guide to the ₹25 lakh leave-encashment exemption explains the four-way test there). If your Form 16 shows gratuity as fully taxable in the new regime, that is a payroll error worth correcting. If your salary TDS looks higher than your actual tax, our guide to salary TDS — Form 12BB, regime declaration and mid-year fixes — explains how to correct it.

5. Report the full amount, then claim the exemption. The whole gratuity goes under Income from Salary, and the exempt portion is claimed under Section 10(10) (Section 19, Schedule II of the 2025 Act). Leaving it out entirely draws a mismatch notice from the AIS — the department sees the payment in your bank credits and in the employer’s reporting. Work out the tax on the taxable slice with the income-tax calculator before you file; if you are nearing 60, read the senior and super-senior citizen tax benefits guide for the exemptions that stack with gratuity at retirement.

FAQs

Is gratuity tax-free up to ₹20 lakh for private employees?
Up to ₹20 lakh, yes — but only the least of three amounts: the actual gratuity received, ₹20 lakh, and the formula amount (15/26 × last drawn salary × completed years, if covered by the Act). Anything above the least of the three is taxable as salary. Government employees are fully exempt with no ceiling.

Is the ₹20 lakh gratuity limit per employer or lifetime?
Lifetime — a cumulative cap across all employers over your whole career. Exemption claimed at an earlier job reduces the ceiling available at the next one.

Do I need to complete 5 years to get gratuity?
Yes, for gratuity to be payable at all under the Payment of Gratuity Act — five years of continuous service with the same employer. The condition does not apply on death or disablement.

Is gratuity exempt under the new tax regime?
Yes. The exemption under Section 10(10) of the 1961 Act (Section 19 read with Schedule II of the Income-tax Act, 2025) is available under both the old and the new regime, because it is an exemption and not a Chapter VI-A deduction.

Sources

Payment of Gratuity Act, 1972 (Sections 4 and 5); CBDT Notification No. 16/2019 (S.O. 1213(E)), dated 8 March 2019 (₹20 lakh ceiling with effect from 29 March 2018); Section 10(10) of the Income-tax Act, 1961, carried forward as Section 19 read with Schedule II of the Income-tax Act, 2025; Payment of Gratuity (Amendment) Act, 2018.