Is gratuity taxable in AY 2026-27? For Central Government, State Government and local authority employees, gratuity is fully tax-free with no limit (Section 10(10)(i)). For private-sector and PSU employees, the exempt amount is the least of actual gratuity, the formula amount and Rs 20 lakh, a lifetime ceiling. Anything above that is taxed as salary at slab rates. The exemption applies under both the old and new tax regimes (Section 10(10), Income Tax Act, 1961; incometaxindia.gov.in).
Gratuity is often the largest single payment a salaried person receives, and whether any of it is taxed depends on two things: who your employer is, and how much you receive. A government employee pays nothing on it. A private or PSU employee gets up to Rs 20 lakh tax-free over their entire career, and pays slab-rate tax on the rest.
This guide is written for the employee receiving gratuity in FY 2025-26 (AY 2026-27). It covers the exemption limits, both calculation formulas, what happens on death or disablement, the new regime, and how to report it in your return. If you are an employer working out liability, provisioning or payment deadlines, see our employer guide to gratuity calculation and compliance.
Who Gets Gratuity
Under the Payment of Gratuity Act, 1972, gratuity is payable to an employee who leaves after at least 5 years of continuous service, on:
- Retirement or superannuation
- Resignation
- Termination (other than the limited forfeiture grounds in the Act)
- Death or disablement due to accident or disease, where the 5-year condition is waived
The Act covers factories, mines, oilfields, plantations, ports, railway companies, and every shop or establishment that employed 10 or more persons on any day in the preceding 12 months. Once covered, an establishment stays covered even if headcount later drops below 10.
From 21 November 2025, the Code on Social Security, 2020 carries these rules forward and adds one change: fixed-term employees qualify after 1 year of service instead of 5.
Tax Exemption Under Section 10(10)
| Employee category | Clause | Tax-free amount |
|---|---|---|
| Central Government, State Government, local authority | 10(10)(i) | Fully exempt, no limit |
| Private or PSU employee covered by the Payment of Gratuity Act | 10(10)(ii) | Least of: actual gratuity, 15/26 formula amount, Rs 20 lakh |
| Private or PSU employee not covered by the Act | 10(10)(iii) | Least of: actual gratuity, half-month average salary formula, Rs 20 lakh |
The Rs 20 lakh ceiling was raised from Rs 10 lakh by CBDT Notification No. 16/2019 dated 8 March 2019, for employees who retired, died, resigned or became disabled on or after 29 March 2018.
Government Employees: No Ceiling
Section 10(10)(i) exempts gratuity received by Central and State Government employees and local authority employees in full, whatever the amount. Defence personnel are covered the same way.
PSU employees are not "government employees" here. Staff of public sector undertakings, public sector banks and statutory corporations such as LIC fall under clause (ii) or (iii) and the Rs 20 lakh ceiling. This is one of the most common errors in self-filed returns.
Private and PSU Employees: Rs 20 Lakh for Life
The Rs 20 lakh is an aggregate across your whole career, not per employer. Any gratuity exemption allowed to you in earlier years, from any employer, reduces what is left. If you claimed Rs 6 lakh as exempt when you left your first job, only Rs 14 lakh of exemption remains for every later gratuity.
The "Rs 25 Lakh" Confusion
Many articles now say the tax-free gratuity limit is Rs 25 lakh. It is not. Rs 25 lakh is the maximum gratuity the Central Government pays its own employees under the CCS (Pension) Rules and NPS gratuity rules, raised from Rs 20 lakh from 1 January 2024 when DA reached 50%. It is a payout cap, not a tax limit, and it changes nothing for private or PSU employees, whose exemption ceiling stays at Rs 20 lakh.
How the Formula Amount Is Calculated
Employees Covered by the Payment of Gratuity Act
Formula amount = 15/26 x last drawn monthly salary x years of service
| Component | Meaning |
|---|---|
| 15 | 15 days' wages for each year of service |
| 26 | Working days in a month |
| Salary | Basic pay plus dearness allowance only |
| Years of service | Completed years; a final part-year of more than 6 months counts as a full year |
HRA, bonus, commission, perquisites and other allowances are not part of salary for this formula.
Employees Not Covered by the Act
Formula amount = 1/2 x average monthly salary x completed years of service
| Component | Meaning |
|---|---|
| Average salary | Average of the 10 months immediately before the month of retirement or exit |
| Salary | Basic pay, DA to the extent it forms part of retirement benefits, and commission fixed as a percentage of turnover |
| Years of service | Completed years only; part-years are ignored |
Worked Example 1: Fully Exempt
A private-sector employee covered by the Act resigns after 12 years. Last drawn basic plus DA is Rs 60,000 a month, and the employer pays Rs 4,15,385.
| Particulars | Amount |
|---|---|
| Formula amount: (60,000 x 15 x 12) / 26 | Rs 4,15,385 |
| Actual gratuity | Rs 4,15,385 |
| Ceiling available | Rs 20,00,000 |
| Exempt (least of the three) | Rs 4,15,385 |
| Taxable | Nil |
Worked Example 2: Above the Ceiling
A private-sector employee covered by the Act retires after 25 years. Last drawn basic plus DA is Rs 1,50,000 a month, and the employer pays Rs 28,00,000.
| Particulars | Amount |
|---|---|
| Actual gratuity | Rs 28,00,000 |
| Formula amount: (1,50,000 x 15 x 25) / 26 | Rs 21,63,462 |
| Ceiling available | Rs 20,00,000 |
| Exempt (least of the three) | Rs 20,00,000 |
| Taxable as salary | Rs 8,00,000 |
The Rs 8 lakh is added to salary and taxed at slab rates. Because it is paid for 25 years of past service, the employee can spread the tax impact by claiming relief under Section 89 with Form 10E.
Worked Example 3: Formula Is the Binding Limit
A private-sector employee not covered by the Act leaves after 9 years and 8 months. The average basic plus DA for the last 10 months is Rs 50,000, and the employer pays Rs 3,00,000.
| Particulars | Amount |
|---|---|
| Completed years (part-year ignored) | 9 |
| Formula amount: 1/2 x 50,000 x 9 | Rs 2,25,000 |
| Actual gratuity | Rs 3,00,000 |
| Exempt (least of the three) | Rs 2,25,000 |
| Taxable as salary | Rs 75,000 |
Had the same employee been covered by the Act, 9 years 8 months would round up to 10 years, and the formula amount would be (50,000 x 15 x 10) / 26 = Rs 2,88,462.
Gratuity on Death or Disablement
The 5-year condition is waived in both cases, but the tax treatment is different.
| Situation | Who receives it | Tax treatment |
|---|---|---|
| Death in service | Nominee or legal heir | Not taxable in the heir's hands (CBDT Circular No. 573 dated 21 August 1990) |
| Disablement, government employee | Employee | Fully exempt under Section 10(10)(i) |
| Disablement, private or PSU employee | Employee | Exempt only up to the least of actual, formula amount and Rs 20 lakh |
Gratuity paid to heirs is not "income from other sources", and it does not need to be shown as taxable income in the heir's return. For a living private-sector employee who leaves on disablement, only the eligibility rule is relaxed; the Rs 20 lakh ceiling still applies.
Gratuity Under the New Tax Regime
The Section 10(10) exemption is available under both regimes. Section 115BAC takes away deductions such as 80C, 80D and HRA, but not the retirement-benefit exemptions: gratuity, leave encashment at retirement under Section 10(10AA) and VRS compensation under Section 10(10C) all survive.
The "Rs 5 lakh limit" some articles attach to the new regime is the VRS compensation exemption under Section 10(10C), a separate benefit. It has nothing to do with gratuity.
For gratuity received from 1 April 2026 (tax year 2026-27), the Income-tax Act, 2025 applies and these salary exemptions sit in Section 19 of the new Act. Gratuity received in FY 2025-26 is governed by Section 10(10) of the 1961 Act.
Gratuity vs Leave Encashment
| Aspect | Gratuity | Leave encashment at retirement |
|---|---|---|
| Section (1961 Act) | 10(10) | 10(10AA) |
| Government employees | Fully exempt | Fully exempt |
| Private employee ceiling | Rs 20 lakh (lifetime) | Rs 25 lakh (lifetime, from 1 April 2023) |
| Eligibility | 5 years' continuous service (waived on death or disablement) | Accumulated earned leave at retirement or resignation |
| Paid while still in service | Not applicable | Fully taxable |
| New regime | Exemption available | Exemption available |
How to Report Gratuity in Your ITR
- Pick the form. Gratuity on its own does not stop you from using ITR-1. Move to ITR-2 if you have capital gains beyond what ITR-1 allows, more than one house property or foreign assets, and to ITR-3 if you have business income.
- Show the full amount in salary. Include the total gratuity in salary under Section 17(1), matching Form 16.
- Claim the exempt part. Under "Allowances to the extent exempt under Section 10", choose Section 10(10) and enter the exempt amount.
- Match AIS and Form 16. Your employer reports the payment, so the return must show it even when all of it is exempt.
- File Form 10E first if you are claiming Section 89 relief on a taxable portion. The relief is not allowed without it.
For AY 2026-27, the ITR-1 and ITR-2 due date was 31 July 2026. If you missed it, a belated return can still be filed by 31 December 2026, with a late fee under Section 234F.
Common Gratuity Tax Mistakes
- Treating Rs 20 lakh as a per-employer limit. It is a lifetime ceiling, reduced by exemptions claimed from earlier employers.
- Assuming PSU or bank employees are "government". They get the Rs 20 lakh ceiling, not full exemption.
- Using CTC or gross salary in the formula. Only basic pay plus DA counts (plus turnover-linked commission for employees not covered by the Act).
- Rounding up service for non-covered employees. The 6-month round-up applies only under the Payment of Gratuity Act.
- Calling disablement gratuity fully exempt for a private employee. Only the 5-year condition is waived; the ceiling still applies.
- Leaving exempt gratuity out of the ITR. Report it and claim the exemption so the return matches AIS and Form 16.
- Skipping Form 10E. A large taxable gratuity in one year can often be taxed less with Section 89 relief.
How Tax Garden Helps
Tax Garden's ITR filing service works out whether you fall under clause (i), (ii) or (iii), computes the formula amount from your service record, checks how much of your Rs 20 lakh lifetime ceiling is left, reconciles the figures with Form 16 and AIS, and files Form 10E where Section 89 relief reduces your tax. For the wider picture on retirement income, see our guides on income tax on pension, income tax for government employees and the old vs new tax regime.
Frequently Asked Questions
What is the gratuity tax exemption limit for private employees in AY 2026-27?
Rs 20 lakh, as a lifetime limit. The exempt amount is the least of the actual gratuity received, the formula amount and Rs 20 lakh (reduced by any gratuity exemption you claimed from earlier employers). Employees covered by the Payment of Gratuity Act fall under Section 10(10)(ii); those not covered fall under Section 10(10)(iii).
Do government employees pay tax on gratuity?
No. Gratuity received by Central Government, State Government and local authority employees is fully exempt under Section 10(10)(i), with no monetary cap. Employees of PSUs, public sector banks and statutory corporations are not government employees for this purpose and get the Rs 20 lakh limit.
Is the tax-free gratuity limit now Rs 25 lakh?
Not for income tax. Rs 25 lakh is the maximum gratuity the Central Government pays its own employees, raised from Rs 20 lakh from 1 January 2024 when DA reached 50%. Their gratuity was already fully tax-free. For private and PSU employees, the Section 10(10) ceiling is still Rs 20 lakh.
Is gratuity paid to the family after an employee's death taxable?
No. Under CBDT Circular No. 573 dated 21 August 1990, gratuity paid to the widow or other legal heirs of an employee who dies in service is not taxable in their hands. It is not income from other sources either.
Is gratuity received on disablement fully tax-free?
Only for government employees. The 5-year service condition is waived on disablement, but a private-sector employee who receives gratuity on disablement is still exempt only up to the least of actual gratuity, the formula amount and Rs 20 lakh.
Is gratuity exemption available under the new tax regime?
Yes. Section 115BAC does not withdraw the Section 10(10) exemption. The same limits apply whether you file under the old or the new regime.
Is the Rs 20 lakh gratuity limit per employer or lifetime?
Lifetime. The Rs 20 lakh ceiling is reduced by any gratuity exemption you already claimed from earlier employers. If you claimed Rs 6 lakh exempt on leaving one job, only Rs 14 lakh of exemption is left for all future gratuity.
How is taxable gratuity reported in the ITR?
Show the full gratuity in salary under Section 17(1), then claim the exempt part under Allowances to the extent exempt under Section 10, choosing Section 10(10). The balance is taxed at slab rates. If the taxable part pushes you into a higher slab, file Form 10E and claim Section 89 relief before filing the return.
Is gratuity paid before 5 years of service taxable?
For a permanent employee who resigns before 5 years without death or disablement, any amount the employer pays is not gratuity under the Payment of Gratuity Act, and is generally taxable as salary. Fixed-term employees are an exception: under the Code on Social Security, 2020 they qualify for gratuity after 1 year.
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Sources
Section 10(10) of the Income Tax Act, 1961 (clauses (i), (ii) and (iii)); CBDT Notification No. 16/2019 (S.O. 1213(E)) dated 8 March 2019 raising the ceiling to Rs 20 lakh; CBDT Circular No. 573 dated 21 August 1990 on gratuity paid to legal heirs; Section 10(10AA) and CBDT Notification No. 31/2023 on the Rs 25 lakh leave encashment ceiling; Section 89 and Rule 21A on relief for gratuity; Section 115BAC on the new regime; the Payment of Gratuity Act, 1972 (Sections 2A and 4); the Code on Social Security, 2020; and the Department of Pension and Pensioners' Welfare order raising the maximum Central Government retirement and death gratuity to Rs 25 lakh from 1 January 2024. Confirm current limits on incometaxindia.gov.in before filing.
