Manesh's friend just resigned and got a "full and final settlement" of ₹4.2 lakh. Gratuity + 38 days of accumulated leave. "Wait, gratuity is real money? And tax-free?"
Real money, yes. Tax-free, mostly yes — up to a limit. Here's the formula and the exemption math.
- Gratuity: payable after 5 years of continuous service. Formula = 15 × last basic × years / 26.
- Up to ₹20 lakh tax-exempt (Sec 10(10) — non-govt). Govt employees: full exemption.
- Leave encashment on exit: up to ₹25 lakh tax-exempt (Sec 10(10AA), private sector).
- Both apply on resignation, retirement, death, or disability.
Gratuity — the formula
Gratuity = 15 × Last drawn (Basic + DA) × Completed years of service / 26
- Eligibility: 5+ years continuous service with same employer
- Exception: death or permanent disability — 5-year rule waived
- 26 = working days/month (Payment of Gratuity Act)
- Years rounded up if > 6 months extra (e.g., 5y 7m = 6 years)
Manesh's gratuity if he leaves now
Last basic ₹40,000/month. 5 years 8 months service → rounded to 6 years.
15 × 40,000 × 6 / 26 = ₹1,38,461. Tax-free (under ₹20L cap). Fully in his account.
Gratuity tax exemption (Sec 10(10))
Non-govt employees
Most of us
Exempt = least of ₹20L, actual received, or formula amount. Anything above ₹20L is taxable as salary.
Govt employees
Central / state
Fully exempt. No cap.
Death / disability
5-year rule waived
Eligible from day 1 of service. ₹20L cap still applies for non-govt.
Leave encashment — Sec 10(10AA)
Unused earned leave (PL/EL) can be encashed at exit. Formula varies by employer policy — typically:
Encashment = Last drawn (Basic + DA) × Unused PL days / 30
Manesh has 38 unused PL days. Basic ₹40k.
Encashment = 40,000 × 38 / 30 = ₹50,667.
Earlier the leave encashment exemption was capped at ₹3L (private sector). Raised to ₹25L in 2023 — most exits now stay below this. Govt employees: full exemption.
Exit-time tax — the 5 things to know
Standard salary TDS. No special treatment.
Form 16 reflects the exempt amount. Above ₹20L = taxable.
Aggregated lifetime cap (not per employer).
Service ≥ 5 years → fully tax-free. < 5 years → taxable as salary in year of withdrawal (TDS 10% if > ₹50k).
60% lump sum tax-free at retirement (60+). 40% goes to annuity (annuity income taxable).
Key gotchas
👉 Resigning before 5 years — no gratuity. (Death / disability exception aside.)
👉 Multiple employers — ₹20L gratuity cap is lifetime aggregate across all employers, not per employer.
👉 Leave encashment during service — taxable in full (no exemption while still working).
👉 Gratuity from unrecognised employer — exemption rules differ; the formula uses 15 days of average salary of last 10 months.
👉 Notice-period pay-out — taxable, no special exemption.
For employers
👉 Provision for gratuity in books from year 1 — actuarial valuation if > 10 employees.
👉 Consider a gratuity trust (group gratuity policy with LIC) — premium is deductible, claim covers payouts.
👉 Leave policy — define max PL accrual + carry-forward (typical: 30 days/year, max 90 days carry).
👉 F&F (Full & Final) settlement within 30-45 days of last working day — delay invites legal action under Payment of Gratuity Act.
Gratuity is the silent ₹1-2L bonus every employee earns at year 5. Most don't even know to ask for it. Employers must pay; employees must claim.
Quick answers
Technically no — 5 years not completed. But Madras HC ruled 4y 240+ days qualifies. Most large employers honour this; small ones don't. Worth requesting.
File complaint under Payment of Gratuity Act with the Controlling Authority (Labour Commissioner). Interest of 10% applies on delayed payment. Strong remedy.
Sec 10(10) applies in both regimes. ₹20L exemption for non-govt employees is available regardless of regime choice.
Yes, taxable as salary. No special exemption. Add to Form 16 income.
Depends on company policy. Most reset. Some honour prior service if rehire is within 6-12 months. Confirm in writing at re-hire.
When you might want help
Single-job employee exit — straightforward. Where help adds value: 5-year boundary disputes (4y 240d cases), gratuity trust setup for employers, large payouts crossing exempt limits with tax planning, and disputes via Payment of Gratuity Act.
Setting up gratuity trust for your company?
LIC group scheme + actuarial valuation + accounting provision — packaged engagement.