Gratuity and Leave Encashment Tax Rules 2026 — Exemption Limits and ITR Reporting

Gratuity and leave encashment are two important retirement benefits that come with specific tax exemptions. Understanding the limits and conditions helps you plan your retirement finances and file your ITR correctly. Here is the complete guide for FY 2025-26.

Gratuity — Tax Rules

What Is Gratuity?

Gratuity is a lump sum payment made by an employer to an employee as a token of appreciation for long service. It is governed by the Payment of Gratuity Act, 1972 for establishments with 10 or more employees.

Eligibility: Minimum 5 years of continuous service (except in case of death or disability).

Formula: Gratuity = (Last drawn salary × 15/26) × Number of completed years of service

Where salary = Basic + Dearness Allowance, and 26 = working days in a month.

Tax Exemption on Gratuity — Section 10(10)

Lifetime limit: The ₹20L exemption is a lifetime limit across all employers. If you receive ₹12L gratuity from Employer A and later ₹10L from Employer B, only ₹8L from Employer B is exempt (₹20L − ₹12L already claimed).

Calculation of Exempt Gratuity (Private Sector — Covered Under Act)

The exempt amount is the least of:

1. Actual gratuity received
2. ₹20,00,000 (statutory limit)
3. (Last drawn salary × 15/26) × Years of service

Example:

• Last drawn salary (Basic + DA): ₹80,000/month
• Years of service: 12 years
• Actual gratuity received: ₹7,50,000
• Calculated gratuity: (₹80,000 × 15/26) × 12 = ₹5,53,846

Exempt amount = Least of ₹7,50,000, ₹20,00,000, ₹5,53,846 = ₹5,53,846 Taxable gratuity = ₹7,50,000 − ₹5,53,846 = ₹1,96,154

Gratuity Received on Death or Disability

Gratuity received on death or permanent disability is fully exempt from tax, regardless of the amount or years of service.

Leave Encashment — Tax Rules

What Is Leave Encashment?

Leave encashment is the payment received for unused earned leave at the time of retirement, resignation, or during service.

Tax Exemption on Leave Encashment — Section 10(10AA)

Important: The ₹25L exemption applies only to leave encashment received at retirement or resignation. Leave encashment received while still employed is fully taxable.

Calculation of Exempt Leave Encashment (Private Sector)

The exempt amount is the least of:

1. Actual leave encashment received
2. ₹25,00,000 (statutory limit)
3. 10 months' average salary (last 10 months before retirement)
4. Cash equivalent of earned leave (maximum 30 days per year of service)

Example:

• Average monthly salary (last 10 months): ₹1,00,000
• Years of service: 20 years
• Earned leave balance: 300 days
• Actual leave encashment: ₹10,00,000

Calculations:

• 10 months' salary: ₹10,00,000
• Cash equivalent of leave (300 days at ₹1,00,000/26 days): ₹11,53,846
• Statutory limit: ₹25,00,000

Exempt amount = Least of ₹10,00,000, ₹25,00,000, ₹10,00,000, ₹11,53,846 = ₹10,00,000 Taxable leave encashment = ₹10,00,000 − ₹10,00,000 = Nil

How to Report in ITR

Both gratuity and leave encashment are reported in Schedule S (Salary) of your ITR:

1. Report the gross amount received under the appropriate head
2. Claim the exempt portion under Section 10(10) or 10(10AA)
3. The taxable portion is added to your salary income

Your employer should reflect these amounts in Form 16 Part B. Cross-check Form 16 with your actual receipts.

TDS on Gratuity and Leave Encashment

Your employer deducts TDS on the taxable portion of gratuity and leave encashment. The TDS appears in Form 16 and Form 26AS.

If the employer has deducted excess TDS (e.g., not accounting for the exemption), you can claim a refund when filing your ITR.

Gratuity and Leave Encashment Under New vs Old Regime

Both exemptions under Section 10(10) and 10(10AA) are available under both the new and old tax regimes. These are not deductions — they are exemptions, which means the exempt amount is not included in your taxable income at all.

Gratuity Received from Multiple Employers

If you receive gratuity from multiple employers during your career:

• The ₹20L lifetime exemption applies across all employers
• Keep track of exemption claimed from each employer
• Disclose previous gratuity exemptions when claiming with a new employer

Frequently Asked Questions

Is gratuity taxable if I resign before 5 years?

If you resign before completing 5 years, you are generally not entitled to gratuity under the Payment of Gratuity Act (except in case of death or disability). If the employer voluntarily pays gratuity, it is taxable as salary income.

Can I claim both gratuity exemption and leave encashment exemption?

Yes. Both exemptions are separate and can be claimed simultaneously. A retiring employee can claim up to ₹20L gratuity exemption and up to ₹25L leave encashment exemption.

Is gratuity received by a nominee after the employee's death taxable?

No. Gratuity received by a nominee or legal heir after the employee's death is fully exempt from tax.

What if my employer has not deducted TDS on gratuity?

If the taxable portion of gratuity is significant, you must pay self-assessment tax and report it in your ITR. Do not assume that no TDS means no tax.

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