Gratuity Rs 20 Lakh Cap: Section 10(10) Explained — Why Online Calculators Still Show Rs 25 Lakh (and Get It Wrong)

If you typed gratuity exemption limit into a search bar this week and landed on a page quoting Rs 25 lakh, you were misled. The tax-free ceiling under Section 10(10) of the Income Tax Act 1961 stands at Rs 20,00,000 and has been frozen at that figure since the Finance Act 2018 came into force on 29 March 2018. The Rs 25 lakh number circulates because the 7th Central Pay Commission raised the gratuity ceiling for Central Government employees to Rs 25 lakh in DA-linked tranches, but that is irrelevant for tax purposes — government servants enjoy a separate, uncapped exemption under Section 10(10)(i). Everyone else, public-sector or private, lives with the Rs 20 lakh wall.

This matters because gratuity is often the third-largest cheque a salaried Indian receives at retirement after EPF and NPS. The difference between a Rs 25 lakh and Rs 20 lakh cap on a Rs 24 lakh payout is Rs 4 lakh of taxable income at slab — up to Rs 1,24,800 in extra tax in the 30% bracket plus 4% cess. Below: the statute, the least-of-three computation, an FY 2026-27 worked example for an Rs 80,000 monthly salary across 12 years, and the drawdown maths that shows how a fully exempt gratuity slots into a Rs 1 crore retirement corpus.

The Scheme Explained

Gratuity is a statutory lump sum paid by an employer to an employee on exit, governed for most private and public-sector workers by the Payment of Gratuity Act 1972 (PGA). The Act applies to every establishment with 10 or more employees and to factories, mines, oilfields, plantations, ports, railways, and shops covered under it. To qualify under Section 4 of the PGA you need 5 years of continuous service with the same employer, with the only carve-outs being death and permanent disablement, where the 5-year rule is waived and the legal heir or employee receives gratuity computed on whatever service was rendered.

The Act fixes the minimum payout. For PGA-covered staff the formula is 15 days of last-drawn wages per completed year, divided by 26 (the deemed working days in a month). Any part-year of 6 months or more rounds up; anything less is dropped. The statutory employer-side cap is also Rs 20,00,000, raised from Rs 10 lakh by gazette notification S.O. 1420(E) dated 29 March 2018 under Section 4(3) PGA. Anything paid above the formula is a contractual ex-gratia, not statutory gratuity.

The tax treatment then layers on top. Section 10(10) of the Income Tax Act 1961 splits taxpayers into three buckets:

The Rs 20 lakh cap appears identically in 10(10)(ii) and 10(10)(iii). It was last revised on 29 March 2018 via the Income Tax (5th Amendment) Rules, 2018, mirroring the PGA gazette change. CBDT Circular No. 573 dated 21 August 1990 (still operative) confirms the cap is lifetime aggregate across all employers and events — once you have used Rs 18 lakh on a 2024 retirement, only Rs 2 lakh remains for any future severance.

Employees of state PSUs, PSBs, RBI, LIC and statutory bodies are not Central Government employees for 10(10)(i) — they fall to 10(10)(ii) and remain capped at Rs 20 lakh.

See our gratuity glossary entry for the difference between wages, salary and basic + DA, and the provident fund glossary entry for how EPF interacts with the same Section 10 chapter.

Tax on Withdrawal

The maths turns on three definitions: last-drawn salary, completed years, and wages. The Section 10(10)(ii) formula uses last-drawn basic + DA that forms part of retirement benefits — that qualifier excludes DA-special, conveyance, HRA, performance pay and the rest of CTC. Under Section 2(s) of the PGA, wages are basic and DA only; bonus, commission, HRA and overtime are excluded.

The 15/26 fraction in 10(10)(ii) reflects the legal fiction that a month has 26 working days (52 weekly offs are excluded). The completed-years rule is generous: 11 years and 6 months becomes 12 years; 11 years and 5 months is 11 years. By contrast 10(10)(iii), for staff not covered under the PGA, uses half a month's average salary of the last 10 months and counts only fully completed years (no rounding). This means an Rs 80,000 employee with 11 years 9 months of service computes as 12 years under 10(10)(ii) and 11 years under 10(10)(iii) — a 1-year delta that costs roughly Rs 46,000 of exemption.

The table below shows the three buckets compared at common service-and-salary points. All figures are in INR.

The Rs 20 lakh wall only bites at the bottom row — Rs 1.8 lakh monthly basic with 30 years of service. Below that, the formula limb binds, not the cap. The Rs 25 lakh myth therefore rarely hurts middle-managers, but it bites at the senior-executive bracket where every rupee of mistakenly assumed cap above Rs 20 lakh is taxed at up to a 39% marginal rate (30% slab + 25% surcharge above Rs 5 crore + 4% cess).

The taxable surplus is taxed under Salaries (Section 17(3), profit in lieu) at the slab rate of the year of receipt. There is no concessional rate and no Section 89 averaging by default; Form 10E relief can spread arrears across the years they relate to. The new-regime Section 87A rebate of Rs 60,000 (FY 2025-26 onwards, per Finance Act 2025) is only available where total income stays below Rs 12 lakh.

Section 80CCD(1B) cannot shelter the taxable portion under the new regime — it is old-regime only post Finance Act 2023. Anyone still on the old regime should time the year of retirement: a Rs 4 lakh taxable surplus pushed into a 0%-or-5% bracket year saves substantially more than the same surplus realised in a 30% bracket year. Our retirement drawdown calculator models the slab impact alongside EPF, NPS and gratuity inflows.

For government employees, Section 10(10)(i) makes the entire gratuity exempt with no monetary, formula or service condition. The DR-linked enhancements that took the Central Government cap to Rs 25 lakh from 1 January 2024 govern what the employer pays, not what is exempt — for these employees the answer is unconditionally fully exempt.

Worked Drawdown

Meet Sumitra, 58, a private-sector finance director retiring on 31 March 2027. She is covered under the Payment of Gratuity Act 1972. Her last-drawn basic + DA is Rs 80,000 per month and she has rendered 12 years and 7 months of continuous service. Her employer's gratuity scheme pays the statutory minimum.

Step 1 — Completed years. Service of 12y 7m rounds up to 13 years because the part-year is >= 6 months (Section 4(2) PGA).

Step 2 — Formula limb (10(10)(ii)). 15/26 x Rs 80,000 x 13 = Rs 6,00,000.

Step 3 — Actual gratuity. The employer pays Rs 6,00,000 (matching the formula).

Step 4 — Exemption. The least of: actual (Rs 6,00,000) / cap (Rs 20,00,000) / formula (Rs 6,00,000) = Rs 6,00,000.

Step 5 — Taxable. Rs 6,00,000 minus Rs 6,00,000 = Rs 0 taxable on the gratuity component.

Now let us layer this into Sumitra's broader corpus over a five-year drawdown horizon. She has Rs 6 lakh gratuity (fully exempt), Rs 48 lakh in EPF, Rs 30 lakh in NPS Tier-I and Rs 16 lakh in mutual funds — a total of Rs 1,00,00,000 at age 58. She intends to draw Rs 50,000 per month for routine expenses, Rs 1 lakh annually for travel and Rs 1.2 lakh annually for medical insurance, with the corpus ex-NPS earning a blended 7.0% per annum. The NPS 60% lump-sum at age 60 (Rs 18 lakh on a Rs 30 lakh corpus assuming no further growth, fully exempt under Section 10(12B)) feeds into the same investment pool; the mandatory 40% (Rs 12 lakh) buys a life-annuity at an indicative 6.5% per annum, paying Rs 78,000 per year for life.

Three points stand out. First, the fully exempt gratuity entered Sumitra's pool intact — at the 30% slab plus 4% cess, missing the exemption would have cost her Rs 1,87,200 of the Rs 6 lakh, eroding the corpus by 1.87% before compounding began. Second, the corpus grows despite the draw because the 7% return exceeds the 7.5% blended draw rate by enough margin once the NPS lump arrives. Third, the Rs 78,000 annuity is fully taxable at slab rates under Section 17(1)(ii) — no exemption attaches to NPS's annuity leg — so its post-tax value is closer to Rs 54,600 in the 30% slab.

The FIRE 4% rule suggests a safe draw of Rs 4 lakh per year on Rs 1 crore. Sumitra's Rs 7.2 lakh draw is 1.8x that — sustainable only because the NPS lump injection at age 60 re-tops the corpus; without it, depletion to Rs 60 lakh by 2031. Use our NPS calculator for the Tier-I projection and the FIRE calculator to back-solve the corpus needed; the coast FIRE calculator lets you stop active contributions while still accruing gratuity service years.

Two boundary cases. If Sumitra had retired at 56 with 4 years 11 months, she would have been ineligible under Section 4(1) PGA — relief would be a fully taxable ex-gratia. Had she died in service at year 4, her nominee would be eligible without the 5-year condition, with the formula on actual service. The death-and-disability override (proviso to Section 4(1)) is the most important PGA carve-out. See the annuity glossary entry for survivor-benefit interaction with NPS continuation.

FAQ

Is the gratuity exemption limit Rs 20 lakh or Rs 25 lakh in 2026?

The tax exemption under Section 10(10)(ii) and 10(10)(iii) is Rs 20 lakh and has been since the Income Tax (5th Amendment) Rules, 2018 took effect on 29 March 2018. Calculators and articles citing Rs 25 lakh are conflating the DA-linked statutory cap for Central Government employees raised on 1 January 2024 with the income-tax exemption — two different things. Government employees do not need any cap because Section 10(10)(i) gives them an unconditional full exemption.

Can I claim Section 10(10) exemption twice in my career?

No — the Rs 20 lakh ceiling is lifetime aggregate across all employers per CBDT Circular No. 573 dated 21 August 1990. If you exempted Rs 14 lakh on a 2019 retirement, only Rs 6 lakh of headroom remains for any future event, including a severance from a second career, a second post-retirement role, or a delayed-vesting payout from an old employer.

What if my employer pays me more than the formula amount?

Anything in excess of (actual gratuity received) capped at the least of formula and Rs 20 lakh is taxable as Salary under Section 17(3). There is no exemption beyond Rs 20 lakh for non-government employees, full stop. If your employer's gratuity scheme pays 30 days per year (instead of the statutory 15/26 of a month), the bonus 50% of the formula is taxable in the year of receipt at slab rates.

Does the Rs 20 lakh cap apply if I die in service or am disabled?

The 5-year continuous service eligibility is waived under the proviso to Section 4(1) of the Payment of Gratuity Act 1972 in cases of death or disablement, but the Rs 20 lakh tax cap is not waived. The exemption available to the legal heir or disabled employee is computed on the same least-of-three basis, with completed years measured at the date of cessation. The Rs 20 lakh cap remains.

Are state PSU and public-sector bank employees treated as government employees?

No. Courts have consistently held that PSU, PSB, RBI and LIC employees are not Central or State Government employees within the meaning of Section 10(10)(i). They fall under Section 10(10)(ii) and are subject to the Rs 20 lakh cap. The only exception is staff drawing pension under the Central Civil Services (Pension) Rules where their cadre is on Central Government rolls.

Can I shelter the taxable portion of my gratuity using Section 80CCD(1B)?

Section 80CCD(1B) gives an additional Rs 50,000 deduction for NPS Tier-I contributions and is only available under the old tax regime. If you opt for the default new regime in FY 2025-26 or later, 80CCD(1B) is unavailable. The taxable surplus from gratuity will be taxed at slab rates with no shelter beyond the Rs 75,000 standard deduction (new regime) or Rs 50,000 (old regime) under Section 16(ia).

Does the Section 87A rebate apply to taxable gratuity?

The Section 87A rebate of Rs 60,000 under the new regime (FY 2025-26 onwards, per Finance Act 2025) and Rs 12,500 under the old regime applies to total income below the relevant threshold (Rs 12 lakh new, Rs 5 lakh old). If your total income — including the taxable gratuity surplus — exceeds Rs 12 lakh under the new regime, the rebate is unavailable. For most retirees with significant gratuity, the rebate ceases to apply in the year of retirement.