Quick Summary
- Outlines eligibility criteria and the formula for calculating gratuity based on continuous service, basic salary, and dearness allowance.
- Provides examples to demonstrate gratuity calculations in various scenarios, ensuring clarity and ease of understanding.
- Discusses recent changes in gratuity laws and regulations for 2024 to keep readers informed and compliant.
Table of Contents
INTRODUCTION
Are you an employee who has completed his/her 5 years of continuous service? If yes, then you are eligible for gratuity in such a case. Understanding how to calculate gratuity ensures you receive the deserved financial benefit for your dedicated years of employment. Or are you an employer, wondering how to calculate gratuity? Before moving on to the steps to calculating gratuity, it is important to know all about it.
Calculating gratuity is crucial for both employers and employees. For employers, it is to ensure that they provide the employees with lawful benefits. For employees, understanding gratuity calculation ensures they receive their entitled amount, aiding in retirement planning. This article will cover the factors affecting gratuity, legal requirements for employers, and common calculation mistakes to avoid, providing a comprehensive guide on how to calculate gratuity accurately.
What is Gratuity?
A gratuity is a form of employee benefit that an employer pays to its employee. It is a part of your salary breakup structure. This is paid as a way of appreciation for their service. It is a payment that is given at the time of retirement, resignation, or death. Gratuity is a main part of an employee’s compensation package. It is calculated based on the employee’s last drawn salary. It also takes into account years of service completed by the employee.
The Payment of Gratuity Act, 1972, is a law in India that governs the payment of gratuity. As per the act, employers pay gratuity to their employees. But only those who have completed five years of continuous service. This applies to factories, mines, oilfields, plantations, ports, railways, and shops, among others.
Key Benefits of a Gratuity Calculator and Its Real-World Relevance
- Accurate Gratuity Estimation: A gratuity calculator provides precise estimates based on your salary and tenure, helping employees understand their potential gratuity payout.
- Time-Saving: It simplifies complex gratuity calculations, saving time and effort that would otherwise be spent manually computing.
- Financial Planning: By estimating gratuity in advance, employees can better plan for their future financial needs, such as retirement or major life events.
- Informed Decision-Making: The calculator aids both employees and employers in making informed decisions regarding job changes, retirement, or other employment decisions.
- Clarity on Legal Compliance: It ensures employees receive the correct gratuity as per the Payment of Gratuity Act, 1972, ensuring transparency and avoiding disputes.Calculation of Gratuity Amount
Calculation and Formula
How to calculate gratuity depends on many factors, mainly the employee’s last drawn salary. It also includes years of service completed by the employee. Along with the maximum amount of gratuity that can be paid to an employee as per the Payment of Gratuity Act, 1972. While calculating gratuity, employers need to adhere to the legal provisions.
To calculate gratuity, use the Gratuity Act Formula mentioned below:
Gratuity = (15/26) x Last Drawn Salary x (Number of Completed Years of Service)
Let’s say, the employee’s last drawn salary is Rs. 50,000 per month, and they have completed 20 years of service. Then the gratuity amount they will get would be:
Gratuity = (15/26) x 50,000 x 20 = Rs. 14,42,307.
Please note that the maximum amount of gratuity to be paid to an employee is Rs. 20 lakhs. Any amount exceeding this limit is not eligible for tax exemption.
Here, “Last Drawn Salary” refers to the employee’s basic salary plus Dearness Allowance. It also includes any other fixed allowance that the employee may be entitled to.
“Number of Completed Years of Service” refers to the total number of years that an employee has worked for the firm This also includes any fraction of a year.
The term “15/26” is a constant factor used to calculate the gratuity amount. The factor of 15/26 is that an employee works for 26 days a month. Thus, completing 15 years of service. Hence, the fraction 15/26 is used to calculate the gratuity amount for each year of completed service.
The factor of 15/26 is used to ensure that the gratuity amount is calculated fairly. All this is based on the last drawn salary and years of service completed by an employee. It is a standard factor used in the calculation of gratuity as per the Payment of Gratuity Act, 1972.
Please note that the factor of 15/26 can be adjusted based on the number of days an employee works in a month. It could also be done in terms of the number of years of service completed.
For example, in the case of seasonal employees, the number of days worked in a year is 240 days instead of 365 days. In such cases, the factor of 15/26 is multiplied by 240/365 to calculate the gratuity amount.
The formula for calculating gratuity for seasonal employees is as follows:
Gratuity = (15/26) x Last Drawn Salary x (Number of Completed Years of Service) x 240/365.
The calculation of gratuity amount in a private company is based on the same formula.
Taxation On Gratuity
Gratuity tax treatment varies by employee type: private sector employees have a tax exemption limit of ₹20 lakhs, with amounts above this subject to income tax based on the applicable tax slab. For instance, if an employee receives ₹25 lakhs, the tax applies to the ₹5 lakhs exceeding the limit. Government employees, however, receive full tax exemption on their gratuity, provided they have completed at least five years of service. The ₹20 lakhs limit is cumulative across all employers, meaning any amount exceeding this from multiple employers will be taxable. Employers must follow legal guidelines for accurate gratuity calculation and payment, and employees should be aware of potential tax implications to avoid surprises.
Related Read: How to Calculate HRA in Salary
Common Mistakes And How To Avoid Them
Employers are responsible for calculating the gratuity amount. And then paying it to their employees in a timely and accurate manner. Yet, mistakes can happen, and employers need to be aware of these common errors to avoid them. Here are some common mistakes and how to avoid them:
- Incorrect Calculation of Service Period. Employers should ensure that they include all the years of service. This also includes the fractional years while calculating the gratuity amount.
- Not Considering Basic Salary. Gratuity is calculated based on the employee’s last drawn salary. This includes the basic salary and dearness allowance. Employers sometimes don’t include the DA along with the base salary. This can result in an incorrect calculation of the gratuity amount.
- Ignoring Changes in Salary. Employers should consider all changes in the employee’s salary. while calculating the gratuity amount. The employer must take into consideration a hike given during the service period. That is how to calculate gratuity.
- Not Maintaining Accurate Records. Employers should maintain accurate records. This should include the employee’s service period and salary details. Incomplete records can result in an incorrect calculation of the gratuity amount.
- Delay in Payment. Employers should ensure that the gratuity amount is paid. This will be paid within 30 days of the employee’s last working day. Payment delays can result in penalties and legal issues.
Also Read: Understanding the Salary Slip
CONCLUSION
Gratuity is a key component of an employee’s compensation, governed by the Payment of Gratuity Act of 1972 in India. It is calculated based on the employee’s last drawn salary and years of service. While private sector employees can receive a tax exemption on gratuity up to ₹20 lakhs, government employees enjoy full tax exemption. Employers must adhere to legal guidelines for accurate gratuity payments. Understanding gratuity calculation and taxation helps employees plan their finances and ensures employers comply with legal requirements.
Want to explore helpful techniques to save and grow your hard-earned money? Dive into our guide on Budgeting.
Frequently Asked Questions(FAQs)
What is the 15/26 rule in gratuity calculation?
If you’re an employer in India, the 15/26 rule is a method of calculating gratuity payments for your employees. Under this rule, you must provide a gratuity payment equal to 15 days of the employee’s last drawn salary for every year they have worked for you, divided by 26. It’s important to ensure compliance with the Gratuity Act of 1972 and make timely payments.
How many years of service are required to be eligible for gratuity?
If you’re an employee in India, you may be wondering how many years of service you need to be eligible for gratuity. According to the Payment of Gratuity Act, of 1972, you must have completed at least 5 years of continuous service with an employer to be eligible for gratuity. However, in case of death or disablement, the minimum service requirement does not apply.
What is the maximum amount of gratuity that can be received?
According to the Payment of Gratuity Act, 1972, the maximum amount of gratuity that can be received is Rs. 20 lakhs. This applies to all employees, whether they work in the public or private sector. It’s important to ensure that your employer is complying with the law and making timely gratuity payments.
How is gratuity calculated for private employees?
If you’re a private sector employee in India, your gratuity is calculated based on the 15/26 rule. This means that for every year of completed service, your employer must pay you a gratuity equal to 15 days of your last drawn salary divided by 26. The formula for calculating gratuity is as follows: Gratuity = (15/26) x Last drawn salary x Completed years of service.
Is gratuity taxable?
If you receive a gratuity as part of your salary package and you are a government employee, the entire gratuity amount is tax-exempt. For private sector employees, however, the tax exemption is limited to a maximum of Rs. 20 lakhs. Any amount received over and above this limit is taxable as per the Income Tax Act. It’s always a good idea to consult with a tax professional to understand your tax obligations.
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