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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, it ensures that they receive the gratuity amount they are entitled to. Thus helping them plan their retirement finances better.
In this article, we will explore the factors that affect gratuity calculation. Also, the legal provisions that employers must adhere to while calculating gratuity. There are some common mistakes that employers make while calculating gratuity. Hence, this article will help you with tips to avoid them. By the end of this article, you will have complete knowledge of how to calculate gratuity.
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.
Calculation of Gratuity Amount
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
The tax treatment of gratuity depends on two options. It is received either by a government employee or an employee from a private firm. The tax exemption limit for gratuity for private sector employees is Rs. 20 lakhs. The amount becomes taxable if it reaches above the limit. This is according to the employee’s income tax slab in the year it is received.
For example, an employee receives Rs. 25 lakhs as gratuity in a year. Then the tax liability on the amount exceeding the exemption limit of Rs. 20 lakhs would be calculated based on the employee’s income tax slab for that year.
But, government employees get full tax exemption on their gratuity amount. No matter the amount received. This exemption is for those who have completed at least five years of service.
Please note that the exemption limit of Rs. 20 lakhs applies to the total gratuity amount received by an employee from all employers. There’s also a case of an employee working for many employers. Here, if the total gratuity amount received exceeds Rs. 20 lakhs, the excess amount will be taxable.
Gratuity is a tax-exempt payment. That means if any amount exceeds the specified limit it is taxable. Employers must ensure that they adhere to the legal provisions while calculating gratuity. The payment should also be made as per the guidelines of the Payment of Gratuity Act. Be aware of the taxation on gratuity to avoid any surprises at the time of receiving the payment.
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
Calculating Gratuity Made it Easier
Gratuity is an important part of an employee’s compensation package. Both employers and employees need to understand its calculation process. The Payment of Gratuity Act, of 1972, governs the payment of gratuities in India. It lays down the formula for calculating the gratuity amount. The formula takes into account two factors. Namely, an employee’s last drawn salary and the number of completed years of service.
The calculation of the gratuity amount can vary depending on certain factors. Based on the type of organization an employee works for. However, the basic formula remains the same. Private sector employees are eligible for tax exemption on gratuity up to a limit of Rs. 20 lakhs. While government employees are eligible for full tax exemption on their gratuity amount.
Employers must ensure that they follow the legal provisions while calculating gratuity. Also the payment is made as per the guidelines specified in the Payment of Gratuity Act. Accurate calculation of gratuity benefits both employers and employees. It is an essential part of an employee’s compensation package.
In summary, understanding the calculation and taxation of gratuity is crucial for employees. It helps them to plan their finances effectively. It is also essential for employers to ensure that they follow the legal provisions. And also that the payment is made accurately and on time.
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Frequently Asked Questions(FAQs)
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.
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.
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.
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.
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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