Gratuity Act Explained: Eligibility, Formula and the ₹20 Lakh Cap

Published July 23, 2026 · Paired with the Gratuity Calculator

Gratuity is a lump sum your employer pays you as a thank-you for long service — a statutory benefit under the Payment of Gratuity Act, 1972. It sounds simple, but the eligibility rule, the formula, and the tax treatment all have wrinkles that surprise people at exit time. This guide walks through each, and you can plug your own figures into the gratuity calculator as you read.

Who is eligible, and the 5-year rule

The Act covers establishments with ten or more employees, and gratuity becomes payable when you leave after at least five years of continuous service with the same employer — on resignation, retirement, or superannuation. The five-year condition is waived if service ends due to death or disablement, in which case gratuity is paid regardless of tenure (to the nominee, in the case of death). One nuance often argued: some courts have held that 4 years and 240 days in the fifth year counts as five years, because "continuous service" is defined partly in worked days — but this is not universally applied, so treat a clean five years as the safe threshold.

The formula — and why 15 and 26

For employees covered by the Act, gratuity is:

Gratuity = (15 × last drawn monthly salary × years of service) / 26

"Last drawn salary" here means Basic + Dearness Allowance, not your full CTC. The 15 represents 15 days' wages for each completed year, and the 26 is the number of working days in a month the Act uses (a month minus its four Sundays). For employees not covered by the Act, a similar formula applies but divides by 30 instead of 26, because it counts all calendar days — which actually produces a slightly smaller figure for the same inputs.

The rounding rule for part-years

Years of service are not always whole, and the Act rounds them a specific way for covered employees: a period beyond six months in the final year counts as a full year, while six months or less is dropped. So 7 years and 7 months is treated as 8 years, but 7 years and 5 months stays 7 years. This single rule can swing your payout by a full year's worth of gratuity, so it is worth timing an exit with in mind. The calculator applies this rounding automatically.

The ₹20 lakh ceiling

However the formula works out, statutory gratuity is capped at a ceiling of ₹20 lakh. If your calculated figure exceeds it, the mandatory amount is limited to ₹20 lakh — though an employer may choose to pay more voluntarily, and that excess is treated differently for tax. The ceiling has been revised upward over the years, which is why it is worth confirming the current figure; our calculator holds it as a dated value that is reviewed against the Budget cycle so it does not silently go stale.

How gratuity is taxed

Tax treatment depends on your category. For government employees, gratuity is fully exempt from income tax. For private-sector employees covered by the Act, the exemption is the least of three amounts: the actual gratuity received, ₹20 lakh, or the amount the 15/26 formula produces. Anything above that exempt figure — typically voluntary gratuity an employer pays beyond the statutory calculation — is taxable as salary. This is why the ₹20 lakh cap matters not just for what you receive, but for how much of it you keep.

A worked example

Suppose your last drawn Basic + DA is ₹50,000 and you served 7 years and 8 months. The rounding rule turns that into 8 years. Covered by the Act: (15 × 50,000 × 8) / 26 = about ₹2,30,769. If you were not covered, the /30 version gives (15 × 50,000 × 8) / 30 = ₹2,00,000 — noticeably less for the same service, which shows how much the covered status is worth. Neither figure is near the ₹20 lakh cap here, so the full amount is payable and, being within the formula limit, exempt from tax.

Points people miss

A few things trip employees up. Gratuity is on Basic + DA, not CTC, so a salary structure with a low Basic quietly shrinks your eventual gratuity. The five-year clock is per employer — changing jobs resets it, which is one hidden cost of frequent switching. Gratuity is separate from your provident fund and is paid on top of it. And your nominee matters: keep the nomination updated, because in the event of death the gratuity goes to whoever is on record. Run your own numbers on the gratuity calculator and check the Basic + DA figure on your pay slip, since that is the number that drives everything.

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