Mostly Gratuity is received as retirement benefits by the employee for rendering long and unblemished service. Gratuity received is added to income for that year and taxable under the head “Income from Salary” and it is also exempt upto certain limit. Gratuity is exempt as under:

In the case of Government employees – In the case of Government employees the whole of the gratuity is exempt from tax.

Gratuity is received under the payment of Gratuity Act, 1972 – Where the gratuity is received under the payment of Gratuity Act, 1972, than the exemption shall be limited to the amount prescribed u/s 4(2) & 4(3) of the said Act. The amended limit put down under the said Act in case of retirement is Rs. 10,00,000/-. Minimum of the following amount is exempt from tax.
a.    Gratuity amount actually received.
b.    15 days’ salary (based on the last drawn salary) for every completed year of service (or part thereof in excess of six months)
c.    Rs.10,00,000/-
Gratuity is not received under the payment of Gratuity Act, 1972 – In other cases, the exemption is available in respect of retirement gratuity, gratuity paid on becoming incapacitated prior to retirement or on termination of employment and gratuity paid on employee’s death to his widow, children or dependents. Minimum of the following amount is exempt from tax.
a.    Gratuity amount actually received.
b.    Half month’s average salary for every completed year of service.
c.    Rs.10,00,000/-
For employees retiring between 1.4.95 to 23.9.97 exemption limit is Rs. 2,50,000/-. The ceiling of exemption is applied to the aggregate of the gratuities in case the same is received from more than one employer in the same year, or in different years.

Where an employee had received gratuity in any earlier year(s) and had claimed exemption u/s 10 (10) in respect of gratuity received earlier also, he will still be entitled to this exemption but the limit which at present is Rs. 10,00,000/- shall be reduced by the amount of exemption(s) availed in the earlier year(s).

Lump Sum payment made gratuitously or by way of compensation or otherwise to the widow or other legal heirs of an employee who dies while in active service is not taxable as income under the Income Tax Act, 1961.

Where an assessee receives gratuity and part of it is taxable because it is not fully exempt u/s 10 (10), the employee can claim relief u/s 89 on account of such gratuity.

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