TDS on Gratuity Under Section 10(10): How to Compute the Exempt and Taxable Portions Correctly

TL;DR

• Gratuity is paid by employers under the Payment of Gratuity Act, 1972, after five years of continuous service.
• Section 10(10) exempts the gratuity received fully for government employees and up to Rs. 20 lakh for non-government employees covered by the Act.
• The exemption formula uses 15 days of salary for every completed year of service for those covered under the Act.
• Any amount above the exemption limit is added to your salary income and your employer deducts TDS under Section 192.
• Like leave encashment, the Rs. 20 lakh exemption is a lifetime cumulative limit across all employers.

What this means in plain terms

Gratuity is the lump sum your employer hands you on the way out, recognising the years you put into the company. The law has carved out a generous exemption to keep this retirement bonus from being eaten away by taxes. But the rules are precise. Section 10(10) divides employees into three categories with different formulas, and the calculation is sensitive to whether your employer is covered by the Payment of Gratuity Act, 1972.

For most private sector employees in companies with 10 or more workers, the employer is covered by the Act, and the formula is half a month's salary for each completed year of service, capped at Rs. 20 lakh. For employees not covered by the Act, the formula is slightly different and uses average salary instead. Knowing which formula applies to you can shift the tax outcome by lakhs.

When gratuity becomes payable

The five-year eligibility rule

Under the Payment of Gratuity Act, you are entitled to gratuity if you have completed at least five years of continuous service with the employer. Continuous service means without a break, though short layoffs or authorised leaves do not break the count. Death or disablement before five years also triggers gratuity payment to the family.

Triggering events

Gratuity is paid on retirement, resignation, superannuation, death, or disability. It is not paid voluntarily during service. The employer must pay within 30 days of the gratuity becoming payable, failing which interest applies under the Act.

Maximum statutory limit

The Payment of Gratuity Act caps the statutory gratuity at Rs. 20 lakh. Employers may pay more on a contractual basis, but anything above this statutory ceiling is potentially taxable depending on the exemption formula.

Section 10(10) categories

Government employees

For Central Government, State Government, defence personnel, and local authorities, gratuity received at retirement is fully exempt under Section 10(10)(i). There is no upper limit. This is the simplest case — the full amount lands in your account tax-free.

Employees covered by the Payment of Gratuity Act

For non-government employees whose employer is covered by the Act, Section 10(10)(ii) applies. The exemption is the least of three amounts — actual gratuity received, fifteen days' salary for each completed year of service (computed as last drawn salary divided by 26 multiplied by 15 multiplied by years), and Rs. 20,00,000.

Employees not covered by the Act

For employees whose employer is not covered by the Act (typically very small employers or specific sectors), Section 10(10)(iii) applies. The exemption is the least of actual gratuity, half-month's average salary for each completed year of service (average over last 10 months), and Rs. 20,00,000.

How TDS is computed on gratuity

Employer's calculation

At the time of full and final settlement, your employer computes the exempt portion using the applicable formula, deducts it from the gross gratuity, and adds the taxable balance to your total income for the year. TDS under Section 192 is then deducted at the average rate on the taxable portion.

Cumulative across employers

The Rs. 20 lakh limit is a lifetime cap. If you received Rs. 8 lakh as exempt gratuity from a previous employer, only Rs. 12 lakh of exemption is available at the next job's separation. You must declare prior gratuity exemptions to your current employer for accurate TDS.

Reflecting in Form 16

The exemption under Section 10(10) is captured in Part B of Form 16 under "less exemptions claimed under Section 10". This becomes the basis for cross-checking when you file your ITR. Discrepancies here can trigger a Section 143(1) intimation.

Common mistakes and clarifications

Counting service years

Six months or more in the final year is rounded up to one full year for the gratuity formula. Less than six months is ignored. So if you worked 7 years and 7 months, you count as 8 years.

Last drawn vs. average salary

For Act-covered employees, the formula uses last drawn basic plus dearness allowance, divided by 26 (treating it as average daily salary in a month). For non-Act-covered employees, the formula uses the average over the last 10 months, which can be lower in years where there was a recent hike.

Contractual gratuity above statutory

Some employers pay a higher contractual gratuity above the Payment of Gratuity Act ceiling. The exemption is still limited to the Rs. 20 lakh statutory cap. The excess is taxable, regardless of whether it is paid as contractual ex-gratia or gratuity.

A real example

Karthik, 60, Rs. 36L CTC, Bengaluru, retires from a private manufacturing company in November 2025 after 32 years of service. His employer is covered by the Payment of Gratuity Act. His last drawn salary (basic plus dearness allowance) is Rs. 1,30,000 per month. He receives Rs. 24,00,000 as gratuity.

Here is the calculation under Section 10(10)(ii):

1. Fifteen days' salary per completed year: Rs. 1,30,000 divided by 26 multiplied by 15 multiplied by 32, that is Rs. 24,00,000.
2. Actual gratuity received: Rs. 24,00,000.
3. Specified limit: Rs. 20,00,000.
4. The least of these is Rs. 20,00,000, so this much is exempt under Section 10(10).
5. The taxable balance is Rs. 4,00,000.
6. This Rs. 4,00,000 is added to his salary income for FY 2025-26. At his slab rate (assuming old regime, 30% slab), this leads to approximately Rs. 1,24,800 in additional tax including cess.
7. His employer deducts this as TDS in the November salary payment. Form 16 Part B shows Rs. 20,00,000 as Section 10(10) exemption.

If Karthik had received an earlier gratuity of Rs. 5 lakh, only Rs. 15 lakh would have been exempt this time, increasing his taxable portion to Rs. 9 lakh.

What to do this week

1. If you are approaching retirement, ask your HR for an estimated gratuity calculation and the exempt portion.
2. Verify whether your employer is covered by the Payment of Gratuity Act — this changes the formula.
3. Keep records of any earlier gratuity exemption claimed to track your Rs. 20 lakh lifetime cap.
4. Cross-check Form 16 Part B to confirm the exemption applied matches your independent calculation.
5. Run the 6-step assessment at https://myfinancial.in to see your old-vs-new regime delta, unused deductions, and insurance gap in under 10 minutes.

FAQ

Is gratuity exemption available under the new tax regime?

Yes. Section 10(10) exemption applies under both old and new tax regimes for AY 2026-27. The change in regime does not affect gratuity treatment.

What if I receive gratuity from multiple employers in one year?

The total exempt amount is still capped at Rs. 20 lakh in your lifetime, not in that year. You must declare prior gratuity to all current and future employers. Failure to do so triggers a notice when the department reconciles across employer records.

Does the five-year service rule apply on death or disability?

No. The five-year eligibility is waived in case of death or disability. Even with less than five years of service, the employer or insurance must pay gratuity to the family or the disabled employee, and Section 10(10) exemption applies.

How does gratuity compare with leave encashment in tax treatment?

Both are governed by Section 10 of the Income Tax Act with similar lifetime exemption caps — Rs. 20 lakh for gratuity under Section 10(10) and Rs. 25 lakh for leave encashment under Section 10(10AA). Government employees enjoy full exemption in both.

Is gratuity paid by trust to employee taxable?

Gratuity paid through an approved gratuity fund is treated the same way as gratuity paid by the employer directly. Section 10(10) exemption applies, and TDS rules are identical.

What if the employer does not deduct correct TDS on gratuity?

You will need to claim the correct exemption in your ITR. The portal will compute the actual tax liability. If TDS is higher than necessary, you get a refund. If less, you pay self-assessment tax along with any interest under Section 234B.

Can a wage settlement include backdated gratuity that triggers Section 89?

Yes, gratuity arrears can also benefit from Section 89(1) relief through Form 10E filing. The rules in Rule 21A apply to gratuity received in arrears the same way they apply to salary arrears.

Sources

• Income Tax Department, Section 10(10): https://incometax.gov.in/
• Payment of Gratuity Act, 1972: https://labour.gov.in/
• TRACES, TDS information: https://www.tdscpc.gov.in/
• CBDT circulars on retirement benefits: https://incometax.gov.in/iec/foportal/

This is general information, not personalised advice. For your situation, consult a Certified Financial Planner.