A few years ago, the central government changed the tax rules regarding employee gratuity payments. According to this amendment, gratuity amounts received by employees are not taxable up to Rs. 20 lakhs.
This tax-free gratuity limit was increased to Rs. 25 lakhs in May 2024 and will come into effect on January 1, 2024.
According to the Payment of Gratuity Act of 1972, the gratuity payable to an employee should not exceed Rs. 25 lakhs.
What is Gratuity?
Gratuity is a benefit a company gives an employee in the form of a monetary payment after they have worked for at least five consecutive years in the same company and then retired.
Gratuity is also paid to the nominee of an employee if the employee dies suddenly or leaves the job due to an accident. In these cases, the five-year condition does not apply. Many people are unsure about how this amount will be calculated. Let’s explore how to calculate it.
Gratuity is a significant benefit for employees, providing a financial cushion even if the employee leaves or retires after working for at least five years in the company. Understanding this benefit is crucial for all employees.
It is applicable in both public and private sectors. Gratuity is calculated based on the employee’s basic pay and Dearness Allowance (DA) during the last service period.
According to the Gratuity Act, 26 monthly working days should be considered for calculation and payment.
Employees who have worked in an organization with ten or more people for at least five years are eligible for gratuity.
If you meet these criteria, you are entitled to an amount equivalent to 15 days’ wages for every year of service, based on your Basic salary, DA, and commission.
It’s important to note that working for more than six months a year is counted as a full year of service. To calculate gratuity, the formula is (monthly pay X 15 X period of service) / 26 (working days).
How is Gratuity Calculated?
Gratuity is calculated using a specific formula: Gratuity Amount = (Last Month’s Salary) x (15/26) x (Years of Service).
Let’s break this down with a simple example. Suppose an employee named Ramu has worked at a company for 7 years and is retiring. His last salary is Rs. 35,000, including the Dearness Allowance (DA) and the basic salary.
- First, we calculate Ramu’s gratuity by multiplying his last month’s salary by 15/26: we get 35,000 x (15/26) = Rs.20,192.31.
- Next, we multiply this amount by the number of years Ramu worked: we get 20,192.31 x 7 = Rs. 1,41,346.17.
- Therefore, Ramu will receive a gratuity of Rs. 1,41,346.17.
Another example, if the basic salary is Rs. 15,000 and the service period is 35 years, the gratuity would be (15,000 x 35) = Rs. 5,25,000.
Then, (5,25,000 x 15) = Rs. 78,75,000. Dividing this by 26 working days per month gives Rs. 3,03,846.15 as the gratuity for 35 years on a basic salary of Rs. 15,000. Basic pay is the only applicable factor for calculation.
What is 15/26 in Calculation?
When calculating gratuity, a year is considered 26 working days multiplied by 12 months. Four days are considered holidays, while the remaining 26 days are regarded as working days. The monthly salary is calculated based on these 26 days.
Gratuity is calculated at the rate of 15 days’ salary for each year of service. If an employee works more than six months a year, that year is counted as a full year. However, that year is not counted if they work for less than six months.
Gratuity Calculation:
Gratuity Formulae = (SxNx15)/26
- S (Salary) = Basic Pay + DA
- N = Number of Years Serviced in the Organization
- 15 = Half month salaried considered for gratuity
- 26 = Average number of days considered (26 = 30-4 Sundays)
Employees are divided into two categories for gratuity calculation:
- Category 1: Employees covered under the Payment of Gratuity Act, 1972.
- Category 2: Employees not covered under the Payment of Gratuity Act, 1972.
Employees in both the private and public sectors fall into either of these categories. The formula for calculating gratuity for employees in Category 1 is: Gratuity = Last month’s salary × Number of years worked × (15/26)