How Gratuity Is Calculated: Rules and Guide 2026

Gratuity is a lump sum your employer pays you when you leave the company after at least 5 years of continuous service. How gratuity is calculated comes down to two inputs: your last drawn salary (basic plus dearness allowance, nothing else) and your total years of service. For someone with a ₹40,000 basic salary and 10 years of service, gratuity works out to roughly ₹2,30,769. That’s money you’ve earned by staying, and most employees have no idea the number is that large until they actually resign.

The reason most people get confused is the gap between what their CTC shows and what the Payment of Gratuity Act actually pays. Your CTC might list a “gratuity provision” of ₹23,000 per year, which is an accounting provision your company sets aside. The actual gratuity you receive at exit is calculated fresh using the statutory method, and it can be significantly higher (or occasionally lower) than the running CTC provision. Let’s get into the real math.

How Gratuity Is Calculated for Private Sector Employees

The calculation under the Payment of Gratuity Act, 1972, works like this: take your last drawn basic salary plus dearness allowance, multiply it by 15, divide by 26, and multiply by your completed years of service. The 15/26 part represents 15 days’ wages for each year of service, with a month counted as 26 working days (not 30 calendar days).

Worked example: your last drawn basic salary is ₹40,000 per month, DA is zero (common in private sector companies). You’ve completed 10 years and 7 months of service. Service over 6 months rounds up, so this counts as 11 years. Gratuity = ₹40,000 × 15 ÷ 26 × 11 = ₹2,53,846.

Now here’s the part most guides skip. “Last drawn salary” means basic plus DA only. It does not include HRA, special allowances, bonuses, or any other component. If your CTC is ₹12,00,000 but your basic is ₹4,80,000 (₹40,000/month), gratuity is calculated on that ₹40,000, not on your total monthly pay of ₹1,00,000. This is why employees with high CTC but low basic salary sometimes receive surprisingly modest gratuity amounts. Check your projected payout using our Gratuity Calculator.

New Gratuity Rules 2026: What Changed and What Didn’t

The phrase “new gratuity rules” generates a lot of search interest because the government’s proposed Labour Code on Social Security (2020) included changes to gratuity eligibility. The key proposed change: reducing the qualifying period from 5 years to 1-3 years for fixed-term and contract employees. However, as of July 2026, the new labour codes have not been fully implemented by all states. The 5-year continuous service requirement remains the operative rule for most private sector employees under the existing Payment of Gratuity Act.

What has changed and is in effect: the maximum tax-exempt gratuity limit was increased to ₹25 lakh (from ₹20 lakh previously) for employees covered under the Act. This means gratuity up to ₹25 lakh received on retirement, resignation, or death is fully exempt from income tax. Anything above ₹25 lakh is taxable at your slab rate.

For government employees, the rules differ. Gratuity is calculated as last drawn salary × years of service × 1/4, and the tax exemption limit is ₹25 lakh as well. Central and state government employees also receive gratuity after 5 years, but their calculation method yields a higher amount per year of service compared to private sector employees.

The 5-Year Rule: When Do You Actually Qualify?

You must complete 5 years of continuous service with the same employer. This is the single most important eligibility rule, and the interpretation of “continuous” catches people in a few common situations.

If you resign after 4 years and 11 months, you get nothing. There is no pro-rata gratuity. The Act requires a minimum of 5 completed years, and courts have consistently upheld this. However, service over 6 months in the final year rounds up to a full year. So 4 years and 7 months of service counts as 5 years for the gratuity calculation, which is a detail many employees miss.

If your company was acquired or merged during your tenure, continuous service typically transfers to the new entity, preserving your gratuity eligibility. If you were terminated or laid off (not for misconduct), you’re still eligible for gratuity after 5 years. Termination for proven misconduct involving moral turpitude (theft, fraud, violence) can result in forfeiture of gratuity, but this is the only grounds for denial.

One question that comes up with contract and gig workers: the current Act applies to establishments with 10 or more employees. If you work for a company with fewer than 10 employees, gratuity is not a statutory obligation (though many smaller companies still pay it voluntarily). The proposed labour codes would expand coverage, but again, those aren’t fully in effect yet.

How Gratuity Shows Up in Your CTC vs What You Actually Get

This confusion costs employees money because they plan around the wrong number. When your offer letter says “CTC: ₹12,00,000 including gratuity provision of ₹23,077,” that ₹23,077 is calculated as 4.81% of your basic salary for that year. It’s an annual provision the company books as a liability.

But the gratuity you actually receive at exit depends on your last drawn salary (which may have increased through raises) and your total years of service (which the annual provision doesn’t account for cumulatively). If you joined at ₹30,000 basic and leave after 8 years at ₹55,000 basic, your gratuity is calculated on ₹55,000, not on the cumulative provisions. The result is usually higher than the sum of annual provisions, sometimes substantially so.

This matters for two planning decisions. First, gratuity is real wealth that accrues over time. Staying an extra year at a company where your basic salary is growing can meaningfully increase your gratuity payout. Second, if you’re evaluating two job offers and one structures more of the CTC into basic salary, that’s not just more take-home, it’s also more gratuity at exit. Our Salary Calculator breaks down CTC into components so you can see exactly how basic salary drives these downstream benefits.

Gratuity Tax Exemption: How Much Is Tax-Free?

For employees covered under the Payment of Gratuity Act, gratuity is exempt from income tax up to ₹25 lakh. For employees not covered under the Act (typically those at companies with fewer than 10 employees), the exemption is the least of three amounts: actual gratuity received, ₹25 lakh, or half a month’s average salary for every completed year of service (where “salary” means basic plus DA averaged over the last 10 months). The calculation is slightly less generous for non-covered employees, but the ₹25 lakh cap applies to both.

If your gratuity exceeds ₹25 lakh (which is possible for senior employees with 25+ years of service and high basic salaries), the excess is taxed as income at your regular slab rate. Given that most employees receive gratuity at the time of retirement or resignation, the tax hit can be managed by ensuring the exit happens in a year where other income is lower.

Gratuity also interacts with your broader exit-year tax planning: EPF withdrawal, leave encashment, and notice period pay all land in the same financial year. Understanding the gratuity component separately helps avoid a surprise tax bill. For your full tax picture, try our Income Tax Calculator, and if you’re also factoring in EPF, our EPF Explained blog covers how that component works.

The bottom line: gratuity is not a gift from your employer. It’s a legally mandated benefit you’ve earned through years of service, calculated on a clear and non-negotiable basis. If you’ve crossed the 5-year mark or you’re approaching it, run the number using the Gratuity Calculator. The result might be the push you need to stay six more months or the confidence to move on knowing what you’re owed.