Tax Laws and Practice · Income under the Head Salary

Gratuity, Leave Salary and Pension Taxability Explained

Updated 11 October 2026 · Fact-checked

Retirement benefits are taxed as salary, but section 19 of the Income-tax Act, 2025 allows deductions up to set limits. For each benefit, find the type of employee, compute the limits, take the least figure where the law says so, and tax only the balance. Pension received monthly is fully taxable.

Understand Retirement Benefits: Gratuity, Leave Salary and Pension

When an employee retires or leaves, the employer may pay gratuity, cash for unused leave, a commuted pension or a voluntary retirement payment. These are salary receipts, so they are chargeable under the head Salaries. The law then gives relief through the deductions in the Table in section 19(1).

The relief is not the same for everyone. Government employees get the entire amount of gratuity and leave encashment as deduction. Other employees get a deduction limited to the least of several figures. So the first question in every problem is: who is the employee?

For gratuity, the rule depends on whether the Payment of Gratuity Act, 1972 covers the employee. If it does, the deduction is the amount received, restricted to what section 4(2) and (3) of that Act allows. For any other gratuity, the deduction is the minimum of three figures: the actual gratuity, the limit notified by the Central Government, and half a month's salary for each completed year of service.

For leave salary, only the cash equivalent received at retirement (superannuation or otherwise) gets relief. For non-government employees the deduction is the minimum of four figures. For pension, commuted pension may get relief, but uncommuted (regular) pension is not in the Table and stays fully taxable. Voluntary retirement compensation gets relief up to ₹5,00,000, with conditions.

Key rules to remember

Gratuity of Government employee (death-cum-retirement): Deduction = entire amount received; Applies to gratuity under the central pension rules or similar schemes for Union, all-India, State civil services and local authority employees, as listed in section 19(2)(g). Defence retiring gratuity is also fully deductible.
Gratuity under Payment of Gratuity Act, 1972: Deduction = amount received, limited to the amount calculated under section 4(2) and (3) of that Act; Use the Act's formula only if the employee is covered by the Act.
Gratuity not covered by the 1972 Act: Deduction = Minimum of (a) actual gratuity, (b) limit notified by Central Government, (c) ½ month's average salary × completed years of service; Average salary is for the ten months before the month of the event. Salary means basic plus dearness allowance if the terms of employment provide for it. All other allowances and perquisites are excluded. Part years are ignored.
Aggregate gratuity limit: Deduction in the year ≤ A − B; A = limit notified by the Central Government. B = gratuity received in earlier tax years that was allowed as exemption or deduction. This applies to gratuity under the 'any other gratuity' entry.
Leave salary of Government employee: Deduction = entire cash equivalent received at retirement; Applies to Central and State Government employees.
Leave salary of other employees: Deduction = Minimum of (a) cash equivalent of earned leave at credit (leave entitlement not above 30 days per year of actual service), (b) 10 × average monthly salary for ten months before retirement, (c) limit notified by Central Government, (d) actual amount received; Salary includes dearness allowance only if terms of employment so provide. The aggregate across employers is also capped at A − B, with B being earlier amounts allowed.
Commuted pension, Government and similar schemes: Deduction = entire amount; Covers the Civil Pensions (Commutation) Rules and similar schemes for civil services, all-India services, defence, State services, and local authority or statutory corporation employees. Also entire amount if received from a fund in Schedule VII.
Commuted pension from other employers: If gratuity received: deduction = commuted value of ⅓ of pension. If no gratuity received: deduction = commuted value of ½ of pension; Commuted value is worked out considering age, health, interest rate and recognised mortality tables. In problems, the ratio is applied to the amount received: deduction = amount received × (⅓ or ½) ÷ (fraction of pension commuted).
Uncommuted pension: Fully taxable as salary; Regular monthly pension has no deduction in the Table.
Voluntary retirement compensation: Deduction = Minimum of (a) compensation received, (b) ₹5,00,000; Scheme must be of a listed employer and follow the prescribed guidelines. Deduction is allowed only once in a person's life, and not where relief under section 157 was claimed for the same amount.
Retrenchment compensation to workman: Deduction = Minimum of (a) compensation received, (b) amount under section 25F(b) of the Industrial Disputes Act, 1947, (c) notified amount, not less than ₹50,000; Compensation on closure or certain transfers of the undertaking is treated as retrenchment compensation. Compensation under an approved scheme is deductible in full.

How to solve Retirement Benefits: Gratuity, Leave Salary and Pension questions

Use the same sequence for any retirement benefit problem. It keeps you from missing a limit or a condition.

1Identify the benefit: gratuity, leave salary, commuted pension, uncommuted pension, VRS or retrenchment compensation.
2Identify the employee: Central or State Government, local authority, covered by the Payment of Gratuity Act, 1972, or any other employee.
3Work out 'salary' for the formula. Take basic and dearness allowance (only if it forms part of terms of employment) and leave out other allowances and perquisites. Use the average of the ten months before the event where required.
4Count completed years of service. Ignore any fraction of a year for gratuity unless the question says otherwise, and use actual service years for the leave entitlement.
5Compute each limit separately and write them in a list. Pick the minimum where the law says minimum.
6Check conditions and earlier claims: the notified aggregate limit, amounts exempted in earlier years, VRS once-only condition.
7Taxable amount = amount received − deduction. Add it to salary income and show the deduction under section 19 in the computation.
8Write a one-line conclusion citing section 19 of the Income-tax Act, 2025.

Quickest way: Least-of-three table method

When to use it: Use for non-government gratuity and leave salary problems where several limits apply.

Draw a two-column table: limit on the left, amount on the right.
Fill in the actual receipt first, then the notified limit, then the formula amount.
Circle the smallest figure. That is the deduction.
Subtract it from the receipt to get the taxable part.
If the employee is a Government employee, skip the table and deduct the full amount.

Common mistakes in Retirement Benefits: Gratuity, Leave Salary and Pension

Treating all gratuity as fully deductible.
Students remember the Government employee rule and apply it to everyone.
Fix: Check the employer first. Only Government and similar scheme gratuity is fully deductible. Others are limited by the 1972 Act formula or the least of three.
Including all allowances and perquisites in 'salary' for the formula.
Salary for the head Salaries is wide, so students use the wide meaning.
Fix: For gratuity and leave salary limits, use basic plus dearness allowance only if the terms of employment provide for it. Exclude everything else.
Rounding up the years of service for gratuity.
Students count 10 years 8 months as 11 years.
Fix: The text says completed years, so use 10. Check the question for any special instruction.
Giving a deduction on regular monthly pension.
Students mix commuted and uncommuted pension.
Fix: Uncommuted pension is taxable as salary in full. Only commuted pension appears in the Table.
Using the wrong fraction for commuted pension of a non-government employee.
Students forget that the fraction depends on whether gratuity was received.
Fix: If gratuity was received use ⅓ of the pension. If not, use ½. Apply it in proportion to the part commuted.
Ignoring earlier-year exemptions and the once-only VRS condition.
Students look only at the current year's facts.
Fix: Read the question for gratuity or leave salary received earlier or from a previous employer, and subtract it from the notified limit. Allow VRS relief only once.

Worked examples

Example 1

Mr. Rohan Mehta retires on 31 January 2027 from a private company not covered by the Payment of Gratuity Act, 1972. He has completed 25 years and 7 months of service. His average salary (basic plus dearness allowance forming part of terms) for the ten months before retirement is ₹60,000 per month. He receives gratuity of ₹8,00,000. Assume the notified limit is ₹20,00,000 and he received no gratuity earlier. Find the taxable gratuity.

Show the solution

Employee is a non-government employee not covered by the 1972 Act, so the deduction is the minimum of three figures under section 19(1), Table, Sl. No. 6.
Actual gratuity received = ₹8,00,000.
Notified limit = ₹20,00,000 (as assumed).
Half month's salary for each completed year: ½ × ₹60,000 × 25 = ₹7,50,000. The 7 extra months are ignored.
Minimum of ₹8,00,000, ₹20,00,000 and ₹7,50,000 = ₹7,50,000. This is the deduction.
Taxable gratuity = ₹8,00,000 − ₹7,50,000 = ₹50,000.

Answer: Deduction is ₹7,50,000 and ₹50,000 of the gratuity is taxable as salary.

Example 2

Ms. Anita Rao, an employee of a private company, retires after 12 years of actual service. She has 340 days of earned leave at her credit and receives ₹3,40,000 as the cash equivalent of that leave. Her average monthly salary for the ten months before retirement is ₹30,000. Assume the notified limit is ₹25,00,000 and she received no leave salary payment earlier. Find the taxable leave salary.

Show the solution

She is a non-government employee, so the deduction is the minimum of four figures under section 19(1), Table, Sl. No. 14.
Actual payment received = ₹3,40,000.
Cash equivalent of earned leave at credit: leave entitlement is capped at 30 days for every year of actual service, which is 30 × 12 = 360 days. Her 340 days are below that, so no reduction applies and the cash equivalent is ₹3,40,000.
10 × average monthly salary = 10 × ₹30,000 = ₹3,00,000.
Notified limit = ₹25,00,000.
Minimum of ₹3,40,000, ₹3,40,000, ₹3,00,000 and ₹25,00,000 = ₹3,00,000. This is the deduction.
Taxable leave salary = ₹3,40,000 − ₹3,00,000 = ₹40,000.

Answer: Deduction is ₹3,00,000 and ₹40,000 is taxable as salary.

Exam tips

Begin every answer by naming the employee type. The marks are in showing you know which rule applies.
Write each limit on a separate line and state the minimum clearly. Examiners award marks for each limit.
Cite section 19 of the Income-tax Act, 2025 and the Table serial number where you are sure of it. Do not cite section 10(10) or other numbers from the Income-tax Act, 1961.
State your assumptions when the question is silent, such as the notified limit or whether dearness allowance forms part of terms of employment.
Mention that uncommuted pension is fully taxable and that earlier exemptions reduce the aggregate limit. These are frequent short-note points.

Practice questions from Income under the Head Salary

Retirement Benefits: Gratuity, Leave Salary and Pension in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Retirement Benefits: Gratuity, Leave Salary and Pension: frequently asked questions

How do I calculate exempt gratuity for a private sector employee?

First check whether the Payment of Gratuity Act, 1972 covers the employee. If it does, the deduction is the amount received, limited to the amount under section 4(2) and (3) of that Act. If not, take the least of actual gratuity, the notified limit, and half a month's salary for each completed year.

Is leave encashment during service exempt?

No. The relief in section 19 is for cash equivalent of earned leave received at the time of retirement, whether on superannuation or otherwise. Encashment during service is taxable as salary.

What is the difference between commuted and uncommuted pension for tax?

Uncommuted pension is regular pension and is fully taxable as salary. Commuted pension is a lump sum in place of pension. It is fully deductible for Government and similar scheme employees. For others the deduction depends on whether gratuity was received.

How much VRS compensation is deductible?

The deduction is the lower of the compensation received and ₹5,00,000. The scheme must be of a listed type of employer and follow the guidelines. It is allowed only once, and not where section 157 relief was claimed on the same amount.