So, what is gratuity? Gratuity refers to an amount of money which an employer pays to his employee in return for services offered by him to the company. It is like a gratitude expressed by the company towards their employees for their services. It is governed by the Payment of Gratuity Act 1972. The Gratuity Act, caps the amount of gratuity at Rs 10 lakh. Any amount in excesses of it will be treated as ex-gratia.
 
Who is eligible for Gratuity?
However, there are a few eligibility criteria which the employee needs to fulfil to receive the gratuity. One such criteria is the completion of at least five years of service or more.  You can receive the gratuity amount only if you have resigned after serving in the company for five years or you have retired from the job.

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However, only those employees who have been employed in the company for five years or more than five years are given gratuity. You should be eligible for superannuation. In case of your death, or if you become disabled on account of sickness or accident.

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Calculation of Gratuity
Gratuity = n*b*15/26 where 'n' is the tenure of service completed in the company and 'b' is the last drawn basic salary + dearness allowance.

Imagine that you worked with XYZ company for a period of 10 years. Your last drawn basic salary along with dearness allowance was Rs 40000. The amount of gratuity = 10*40000*15/26 = Rs 230,769.23

The time-period of service is rounded-off for gratuity calculation. If the last few months in the last year of employment are more than 6 months, then it will be rounded to next number. For eg. 10 years and 8 months will become 11 years. Upto five months the same year will be counted. For eg if the period of service is 10 years and 4 months, it will be treated as 10 years.

Tax treatment
Gratuity received by an individual is taxable entity as per existing laws. The gratuity received by government employees -  be it at the state or Centre, on their superannuation/retirement/termination is exempt from tax.

For private employees, tax exemptions on gratuity depend on whether they fall under ambit of the Payment of Gratuity Act of 1972. Differential tax treatment is provided based on this criteria.

Gratuity received by employees who are covered under the Act is tax exempted under either of the three conditions. Gratuity amount of Rs 10 lakhs or salary equivalent to 15 days of service for each year completed or actual gratuity received. In cases where the gratuity amount exceeds the exemption limit, it will be taxed as per prevailing conditions.

Private sector employees who are not covered under the Act are also exempted of income tax under the following conditions. Actual gratuity received; gratuity of Rs 10 lakhs; amount equivalent to half month salary for every year of service. Any amount exceeding the aforementioned minimum limit is liable to be taxed.

Gratuity received by a nominee/heir on the demise of an employee, falls under the head 'Income from other sources' and is liable to be taxed.