Learn gratuity under the Income Tax Act with PensionBox

Who does not aspire to earn extra income? Even a little extra makes a significant difference in the lives of the middle class. It helps them save more for retirement. So, as an acknowledgment and appreciation for your service, employers provide their employees with a financial reward in the form of a gratuity. Gratuity is administered by the Payment of Gratuity Act, of 1972. Individuals are drawn towards gratuity because it is tax-exempt under Section 10 of the Income Tax Act.

In this article, we shall decode gratuity under the Income Tax Act and its various aspects. For full insights, read the article till the end.

What is gratuity?

Gratuity is a monetary reward provided to the employee by the employer to show appreciation and thankfulness for the services provided by the employee.

Gratuity is generally paid when:

• 1. an employee retires
• 2. an employee resigns
• 3. an employee is dismissed after they have completed the minimum number of years of service, as mandated by the employer.

How do I calculate gratuity?

To calculate gratuity, you can use the formula given below.

It must be noted that, as per the latest amendment, the maximum amount of gratuity payable under the Payment of Gratuity Act is capped at Rs. 20 lakhs.

Let us try to understand this through an example,

Let's assume that Akriti is an employee, and her last drawn salary (that includes Basic and DA) was ₹1,00,000 per month. She was in service for a continuous period of 20 years. Let's try and calculate the gratuity received by her.

Who is entitled to claim gratuity under the Income Tax Act?

The eligibility to claim gratuity under the Income Tax Act is as follows:

• 1. Any individual who is working as an intern and is receiving a stipend is not entitled to gratuity. Only those employees who are working full time and receiving wages are entitled to gratuity.
• 2. The employee must have served for a minimum of 5 years to claim gratuity. However, in cases of death or sudden disability, the 5-year rule does not apply.

Who is an employee?

As we have seen, an employee can claim a tax exemption on gratuity under the Income Tax Act under the specified provisions. But who is an employee? When can an individual be called an “employee” to claim tax exemption on gratuity under the Income Tax Act?

An employee is- Any working individual—for instance, working in a shop, industry, factory, coal mine, etc.–– who is working full-time and receiving wages can be called an “employee,” and is entitled to claim a tax exemption gratuity under the Income Tax Act.

When can an employee claim gratuity under the Income Tax Act?

• 1. An employee can claim gratuity at retirement.
• 2. An employee can claim gratuity on superannuation.
• 3. An employee can claim gratuity on resignation.
• 4. An employee can claim gratuity on termination.
• 5. Gratuity can be claimed on death or impairment due to an accident or any other issue.
• 6. An employee can claim gratuity on layoff.
• 7. An employee can claim gratuity if he opts for the VRS (Voluntary Retirement Scheme).

Taxation of Gratuity

The taxation system for gratuities differs from employee to employee. Let's understand more about this.

• 1. Government Employee: For a government employee, including employees of legal corporations, local authorities, and institutions accustomed to a Central or State Act, gratuity is fully exempt from tax.

• 2. Non-Government Employee: For a non-government employee covered under the Payment of Gratuity Act, the tax exemption can be calculated based on the formula: Exemption = (15/26) × Last drawn salary× Number of years of service. The maximum exemption permitted under this provision is ₹20 lakh.

• 3. Non-Covered Employees: For employees not covered under the Payment of Gratuity Act, the tax exemption varies from the previous. Here, it is the least of the following:

a. For each year completed in service, half of the month's salary hinged on the average salary of the last 10 months immediately preceding the month of retirement. b. Rs. 20 lakhs c. Actual gratuity received

To ensure compliance with the Income Tax Act, an individual must understand the meaning and aspects of gratuity. Gratuity serves as a great monetary benefit, but understanding the taxation system of gratuity is equally important to plan retirement efficiently. And if you come across any confusion or problems in your retirement planning, PensionBox is always there to make your retirement planning experience great.