How to calculate of gratuity
Gratuity is a monetary benefit provided to employees as a gesture of gratitude for their years of service. It plays a crucial role in determining an employee’s financial security during retirement. Employers typically pay gratuity to employees who have completed five or more years of service. In this article, we’ll explain how to calculate gratuity and important factors to consider when determining the amount.
1. Understand the Eligibility Criteria
Before calculating gratuity, it’s essential to determine if an employee is eligible. As per the Payment of Gratuity Act, 1972, an employee must fulfill two criteria:
a. The employee has completed at least five years of continuous service with the employer.
b. The employee falls under one of the following categories: superannuation or retirement, resignation, or death.
2. Consider Different Formulas for Different Employment Types
The formula for calculating gratuity depends on whether the organization falls under the Payment of Gratuity Act or not:
a. Organizations covered by the Payment of Gratuity Act:
Gratuity = (15 x Last Drawn Monthly Salary x Years of Service)/26
b. Organizations not covered by the Payment of Gratuity Act:
Gratuity = (1/2 x Monthly Salary) x Completed Years of Service
3. Breakdown the Gratuity Calculation Process
For organizations covered by the Payment of Gratuity Act, follow these steps:
i. Calculate the employee’s last drawn monthly salary (which includes basic salary, dearness allowance, and commissions based on sales).
ii. Multiply this salary figure by 15.
iii. Multiply this value by years of service.
iv. Divide this value by 26 to determine the gratuity amount.
4. Don’t Forget the Monetary Cap
According to the Payment of Gratuity Act amendments as of March 2018, there is a maximum limit on the gratuity amount. The limit is ₹20,00,000, meaning that an employee cannot receive gratuity exceeding this amount, irrespective of the calculation result.
5. Understand Tax Implications
Gratuity is tax-exempt for government employees. However, non-government employees may be subject to taxes on their gratuity amount as per Section 10 (10) of the Income Tax Act. Typically, the minimum of the following three scenarios will be exempt from tax:
a. The actual gratuity amount received.
b. 15 days’ salary for each completed year.
c. ₹10,00,000 (updated limit as of FY 2019-20).
Conclusion
Understanding how to calculate gratuity is essential for both employers and employees to ensure appropriate financial planning and security during retirement. Always keep in mind the legal aspects, applicable formulas, and tax implications when calculating gratuity. By following these steps and staying informed about changes in laws and regulations, you’ll be well-prepared to navigate this critical aspect of employment benefits.