How to calculate gratuity and is gratuity taxable?



Gratuity is a kind of benefit that an employer gives to the employees. The recent amendment that has been approved by the parliament has increased the maximum limit of gratuity that is taxable. As per the recent amendment in the taxation laws in India, gratuity is tax exempt up to Rs 20 lakhs. Earlier this ceiling was Rs 10 Lakhs. The taxation procedures for gratuity is covered by Section 10(10) of the Income Tax Act.

Notification

The CBDT Notification no. S.O. 1213(E), dated 8 March 2019, states that the tax exemption on gratuity to an upper limit of Rs 20 lakh is made available to employees if the employee resigns or disabled, or retires or dies on or after 29 March 2018.

What is gratuity?

The monetary benefit called as gratuity given by the employer to the employees is given under the provisions found in the Payment of Gratuity Act, 1972. Gratuity is paid to the employee in case of the following.

Case-1: The employee retires from the organization after attaining the age of retirement or resigns from the organization.

Case-2: superannuation meaning the employee attaining the age of retirement while still working in an organization.

To qualify for gratuity in the two cases mentioned above, the employee must have completed 5 years of service in the given organization that is supposed to pay gratuity.

Case-3: death or disablement of the employee due to an accident or disease )in this case, the time limit of 5 years that must be completed for qualifying for gratuity does not apply).

Who is covered under gratuity

All employees working in factories, mines, ports, railways, plantations, enterprises, shops, oil fields and educational institutions that have 10 or more employees on its rolls on any given day in the preceding 12 months are eligible to get gratuity. Once the gratuity law becomes applicable to the employer, the employees will invariably get gratuity even if the number of employees fall below 10 eventually.

How to calculate the amount of gratuity that is tax exempted

In the following cases, whichever is the least one is exempted from tax:

  • Last salary drawn including basic X DA and the number of years employed X 15.26.
  • Rs. 20 lakhs
  • The gratuity amount actually received by the employee
For example, let us consider Karthik is employed for 25 years and 2 months. The average salary for the last 10 months in his case is Rs. 90,000. The actual gratuity he will receive is Rs. 11 lakhs.

Average of last 10 months’ salary: Rs.90,000

Number of years employed: 25 (rounded off to the nearest year).

Gratuity amount receivable: 90,000*25*1/2 = 11,25,000

Maximum amount allowed for tax exemption: 10 lakhs as per the earlier taxation law

Amount exempted from tax as per the rule of least of the three: Rs. 10 lakhs

Resulting taxable gratuity: Rs 1 lakh

Note: Karthik need not pay any taxes on his gratuity amount once his gratuity is dealt with by the amended taxation laws that permit Rs 20 lakh upper limit to gratuity.
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