Gratuity Rules 2026: Labour Code Changes, Formula, Tax

Gratuity is the salary component everyone ignores until year four of a job, and then suddenly cares about a great deal. It's a lump-sum thank-you payment your employer owes you for long service, it's backed by law, and depending on your basic salary it can be a genuinely large amount of money.

Since 21 November 2025 gratuity is governed by the Code on Social Security, 2020, which replaced the Payment of Gratuity Act, 1972. The formula survived; the wage base, the rules for fixed-term staff and a few details changed. Here is how eligibility works now, how to calculate yours, how it is taxed, and what happens when you leave.

What changed on 21 November 2025

• Wages have a single definition across the labour codes: basic pay, DA and retaining allowance. If your other allowances are more than 50% of your total pay, the excess is added back to wages, which raises gratuity for anyone with a low basic.
• Fixed-term employees no longer need five years. When a fixed-term contract ends, gratuity is paid pro-rata; the Labour Ministry says one year of service qualifies.
• The ceiling is ₹20 lakh, the amount the government has notified.
• It is prospective. The ministry says the Code's gratuity provisions apply from 21 November 2025. Earlier years of service still count.

More on the wider changes is in how the labour codes change your salary.

What gratuity is and who's covered

Gratuity applies to establishments with 10 or more employees, which covers almost every company you are likely to work for. Once covered, an establishment stays covered even if its headcount later drops.

The core promise: serve long enough, and your employer must pay you a lump sum when you leave, retire, or in unfortunate cases, to your nominee.

Eligibility: the 5-year rule

You become eligible for gratuity after 5 years of continuous service with the same employer, subject to conditions. Key nuances:

• The 5 years must be continuous service: approved leave, maternity leave and similar breaks generally don't break continuity.
• The 5-year requirement is waived in case of death or disablement: the payment goes to the employee or their nominee regardless of tenure.
• You may have heard that "4 years and 240 days" counts as 5 years. Courts have ruled this way in several cases, and many employers honour it, but treat it as something to negotiate or verify, not a guarantee.
• Fixed-term contracts are the exception: at the end of the contract, gratuity is pro-rata after one year of service.
• Company gratuity schemes can be more generous than the law (some pay before 5 years), never less.

Practical takeaway: if you're at 4.5 years and thinking of quitting, check the math. Sticking around a few more months could be worth a lakh or more.

The formula: 15/26 explained

For employees of covered establishments, gratuity is:

Gratuity = 15/26 × last drawn wages × years of service

Breaking that down:

• 15/26, you get 15 days' wages for every year of service, and a month is counted as 26 working days. So each year of service earns you roughly 57.7% of one month's basic+DA.
• Last drawn wages: basic plus dearness allowance (and retaining allowance, if any) in your final month, not your gross or CTC. Under the labour codes, allowances above 50% of your total pay are added back. This is one more reason basic salary matters so much (see how to read your salary slip).
• Years of service: service beyond 6 months in the final year is rounded up to a full year. So 7 years and 8 months counts as 8 years; 7 years and 4 months counts as 7.

Worked example

Say Priya resigns after 8 years and 7 months, with a last drawn basic of ₹60,000/month (no DA):

1. Years of service: 8 years 7 months → rounds up to 9 years.
2. Gratuity = 15/26 × ₹60,000 × 9
3. = ₹34,615 (approx. per year of service) × 9
4. = ₹3,11,538

So Priya walks away with roughly ₹3.1 lakh, tax-free (more on that next). Run your own tenure and basic through the gratuity calculator to get the payable amount and the exempt-versus-taxable split in one step. Notice how much basic matters: if her basic had been ₹80,000, the same tenure would pay about ₹4.15 lakh. Gratuity scales directly with basic, a structure with a healthy basic quietly builds this up for you.

Taxation: the ₹20 lakh shelter

For private-sector employees, gratuity received is tax-free up to ₹20 lakh, a lifetime limit across employers. The exemption was section 10(10); under the Income-tax Act, 2025 it is in section 19, and it applies in both regimes. The exempt amount is the least of:

• The actual gratuity received,
• The amount per the 15/26 formula, and
• ₹20 lakh.

Anything above the exempt amount is taxed as salary at your slab rate. For government employees, gratuity is fully exempt. In practice, unless you have a very high basic and very long tenure, your entire gratuity is likely to be tax-free, a rare full exemption that survives regardless of tax regime. To see how a gratuity payout year affects your overall tax picture, run the numbers through the income tax calculator.

The "gratuity inside CTC" controversy

Here's where people get annoyed, justifiably. Many companies include a gratuity accrual, roughly 4.8% of basic per year, inside your CTC. The problems:

• It inflates your CTC with money you only receive after 5 years, subject to conditions. Leave at year 3 and that "component" simply evaporates.
• It's a statutory employer obligation, arguably not "your" compensation until it vests.
• Two identical offers can look different purely because one counts gratuity in CTC and the other doesn't.

Including it isn't illegal, CTC is an accounting construct, not a legal term, but you should mentally strip it out when comparing offers. Our CTC vs gross vs in-hand guide walks through the full list of such phantom components, and the in-hand salary calculator shows what any structure actually pays month to month.

Resignation vs termination vs retirement

What triggers a payout, assuming you've crossed 5 years:

• Resignation: fully eligible. Gratuity is usually settled with your full and final settlement and must be paid within 30 days of becoming due; delays attract interest. See full and final settlement rules.
• Retirement or superannuation: fully eligible, same formula.
• Termination / layoff: still eligible. Being let go does not cost you gratuity.
• Termination for proven misconduct: this is the exception, gratuity can be forfeited, wholly or partly, in cases involving offences like riotous conduct or acts of moral turpitude during employment, following due process. A plain performance-related exit does not qualify for forfeiture.
• Death or disablement: paid to the employee or nominee with the 5-year rule waived. This is why you should actually fill in the gratuity nomination form when HR asks; most people skip it.

If an employer wrongly withholds gratuity, you can file a claim with the authority for your state. It is an enforceable right, not a discretionary bonus.

The bottom line

• Eligibility: 5 years of continuous service, waived on death or disablement; one year, pro-rata for fixed-term contracts.
• Formula: 15/26 × last drawn wages × years of service, with final-year rounding in your favour past 6 months.
• Tax: exempt up to ₹20 lakh for private employees, in both regimes.
• In CTC? Mentally deduct it when comparing offers, it's deferred, conditional money.
• Always name a nominee, and always check the math in your full-and-final settlement.

A higher basic today means a bigger gratuity tomorrow, one more reason to look past the CTC headline and understand your actual salary structure.

Frequently asked questions

What are the new gratuity rules in 2026?

Since 21 November 2025 gratuity falls under the Code on Social Security, 2020. The formula is still 15 days' wages per year of service, but wages now follow the labour codes' definition, fixed-term employees get gratuity pro-rata after one year, and the ceiling is ₹20 lakh.

Is gratuity payable before 5 years?

For permanent employees, only on death or disablement. Fixed-term employees get it pro-rata at the end of their contract; the Labour Ministry says one year of service qualifies.

Is gratuity calculated on basic or gross salary?

On wages: basic, DA and retaining allowance. If your other allowances exceed 50% of total pay, the excess is added to wages for the calculation.

Is gratuity taxable?

For private-sector employees, it is tax-free up to the least of the amount received, the formula amount and ₹20 lakh, in both regimes. Government employees are fully exempt.