Is Gratuity Taxable in India? What HR Teams Need to Know in 2026

Gratuity is partially taxable in India. While it serves as a statutory retirement benefit, its tax treatment depends entirely on an employee's sector and whether their organization falls under the Payment of Gratuity Act, 1972, which is an Indian labour law requiring employers to pay a financial benefit to employees upon retirement, resignation, termination, death, or disablement.

For private-sector HR and payroll teams, compliance requires navigating Section 10(10) of the Income Tax Act which governs the tax exemption of gratuity received by an employee upon retirement, resignation, death, or superannuation.

Most employees think of gratuity as just a lump-sum payment they receive when leaving a job. But from a tax professional's perspective, it can also be a tax-efficient part of your retirement savings, because a significant portion of it may be exempt from tax, depending on your eligibility and the applicable tax rules.

---

Section 10(10) of the Income Tax Act, 1961

The Payment of Gratuity Act, 1972 tells you who is entitled to gratuity and how it is calculated. Section 10(10) of the Income Tax Act, 1961 decides how much of that gratuity is exempt from income tax. For employees covered under the Payment of Gratuity Act, the exemption limit is currently up to ₹20 lakh, subject to the applicable calculation rules. Government employees generally receive full tax exemption on eligible gratuity.

Here, exemption simply means the portion of your gratuity on which you do not have to pay income tax. For example:

You receive ₹15 lakh as gratuity

Suppose the entire ₹15 lakh qualifies for exemption

You don't pay income tax on that ₹15 lakh

But if you receive ₹25 lakh and only ₹20 lakh qualifies for exemption, then:

₹20 lakh → tax-free

Remaining ₹5 lakh → may be treated as taxable income, depending on the applicable rules

So, gratuity exemption is equal to the amount of your gratuity that the government allows you to receive without paying income tax on it. The ₹20 lakh is the maximum exemption limit, not necessarily an amount that everyone automatically gets tax-free.

From an HR perspective, the biggest thing to understand is that Section 10(10) is not about whether an employee gets gratuity. That is governed by employment and gratuity law. Section 10(10) deals with how much of the gratuity received is exempt from income tax.

---

How Much of Your Gratuity Is Tax-Free?

Receiving gratuity and getting a tax exemption on gratuity are two separate matters.

The Payment of Gratuity law determines whether an employee is entitled to receive gratuity and how the amount is calculated. Section 10(10) of the Income Tax Act determines how much of that gratuity can be excluded from taxable income. The tax treatment depends on the type of employee. Before calculating the exempt amount, HR and payroll teams should first identify which category the employee falls into.

Government Employees

The tax treatment of gratuity for Central and State Government employees is different from that of most private-sector employees. For AY 2026–27, the Income Tax Department's validation rules specify an exemption limit of up to ₹25 lakh for employees and pensioners in the Central and State Government categories. This means HR teams should not use ₹20 lakh as a universal gratuity tax exemption limit for every employee.

Employees Covered Under the Payment of Gratuity Act

For employees covered under the applicable gratuity provisions, the tax-exempt amount is generally the lowest of:

The applicable maximum exemption limit

The actual gratuity received

The amount calculated using the prescribed formula

The calculation is generally based on:

For this calculation, a period of service exceeding six months may be counted as a full year. For AY 2026–27, the Income Tax Department's validation rules specify a maximum exemption limit of ₹20 lakh for PSU and other non-government employee categories.

Employees Not Covered Under the Payment of Gratuity Act

Employees who are not covered under the Act may also receive a gratuity tax exemption, but the calculation is different. The exempt amount is generally the lowest of:

₹20 lakh

The actual gratuity received

The amount calculated using the prescribed formula

The formula is:

This means the ₹20 lakh figure is a maximum ceiling. It does not mean that every employee automatically receives ₹20 lakh as tax-free gratuity. If the gratuity received is higher than the eligible exemption, the remaining amount may become taxable.

Tax Reporting and Payroll Records

HR and payroll teams should maintain accurate records of the employee's:

Date of joining and leaving

Length of continuous service

Salary details used for gratuity calculations

Actual gratuity paid

Gratuity exemption claimed, where relevant

For AY 2026–27, the Income Tax Department's validation rules require that the gratuity exemption claimed under Section 10(10) does not exceed the gratuity reported as salary income or the applicable exemption limit. If a part of the gratuity is taxable, the employee may also be eligible for relief under Section 89, depending on their circumstances.

---

Gratuity Eligibility

Gratuity eligibility and gratuity calculation are two different things. In general, an employee becomes eligible for gratuity after completing five years of continuous service with the same employer. However, this five-year requirement does not apply when employment ends because of the employee's death or disablement.

HR teams should also be careful not to confuse the rules used for calculating gratuity with the rules that determine whether an employee has become eligible for it.

How Service Is Counted for Gratuity Calculation

For employees covered under the gratuity law, a period of service exceeding six months is treated as a full year when calculating the gratuity amount. For example, an employee who has completed 5 years and 7 months of service may have their gratuity calculated based on 6 years of service.

However, this calculation rule should not automatically be treated as an eligibility rule. For employees not covered under the Act, the tax exemption calculation generally considers only completed years of service, and a fraction of a year is not counted in the same way.

What About the 4 Years and 240 Days Rule?

You may have heard that an employee becomes eligible for gratuity after completing 4 years and 240 days of service. This interpretation comes from the definition of continuous service and has also been considered in various court decisions.

However, this should not be treated as a universal rule that automatically applies to every employee and organisation. HR teams should review the applicable law, the facts of the employee's service and relevant judicial decisions before relying on the 4 years and 240 days interpretation for gratuity eligibility.

Death and Disablement

The five-year continuous service requirement does not apply when an employee's service ends because of death or disablement. In such cases, gratuity can become payable even if the employee has not completed five years of service.

---

2026 Labour Code Updates

Under the Code on Social Security, 2020, as reflected in the Ministry of Labour and Employment's 2026 FAQs, a fixed-term employee becomes eligible for gratuity after completing one year of service under the contract. The five-year requirement does not apply in the same way to fixed-term employment.

HR teams should therefore identify whether an employee is engaged on a fixed-term contract before applying the standard five-year eligibility rule.

The Labour Codes also introduce a uniform definition of wages. Under the 50% rule, if the excluded components of an employee's remuneration exceed the permitted limit, the excess amount may be added back to wages for statutory calculations.

This can affect the wage base used for statutory benefits, including gratuity. The Ministry of Labour and Employment has clarified the treatment of various salary components under the 50% rule and its application following the implementation of the Codes.

HR teams should therefore review salary structures instead of assuming that simply keeping Basic Pay below 50% will reduce statutory liabilities.

---

Things an HR Professional Should Know About Gratuity and Tax Exemption

The first step is to identify the type of employee. The tax exemption on gratuity is not the same for everyone. Government employees, employees covered under the Payment of Gratuity Act, and employees not covered under the Act may be taxed differently.

For most non-government employees, ₹20 lakh is the maximum amount that can be exempt from tax. However, this does not mean every employee automatically gets ₹20 lakh tax-free. The actual exempt amount may be lower.

The final tax-free amount depends on three things: the gratuity received, the amount calculated under the applicable formula, and the maximum exemption limit. The employee generally gets an exemption based on the lowest applicable amount.

For example, an employee may receive ₹18 lakh as gratuity, but the full ₹18 lakh may not necessarily be tax-free if the applicable calculation results in a lower exempt amount.

Government employees may have a different exemption limit. For AY 2026–27, the applicable Income Tax Department validation rules show a limit of ₹25 lakh for Central and State Government employees and pensioners, while the limit for PSU and other non-government employees is ₹20 lakh.

In simple terms, Section 10(10) decides how much of an employee's gratuity is tax-free. Any amount that does not qualify for exemption may be added to the employee's taxable income.

---

FAQs