Tax on gratuity, leave encashment and commuted pension
Updated 11 October 2026
At retirement, three lump sums matter most: gratuity, leave encashment and commuted pension. For central and state government employees, all three are fully tax-free. For private-sector and most PSU employees, gratuity is tax-free up to ₹20 lakh, leave encashment up to ₹25 lakh (subject to a formula), and one-third or one-half of the commuted pension, under both the old and the new regime.
Where the rules are
These exemptions were in section 10(10) (gratuity), 10(10A) (commuted pension) and 10(10AA) (leave encashment) of the 1961 Act. From tax year 2026-27 they are in section 19 of the Income-tax Act, 2025, alongside the standard deduction. They are not among the benefits the new regime takes away, so they apply whichever regime you choose.
| Lump sum | Central and state government employees | Other employees (private sector, most PSUs) |
|---|---|---|
| Gratuity | Fully exempt | Exempt up to the least of three limits, at most ₹20 lakh |
| Leave encashment at retirement | Fully exempt | Exempt up to the least of four limits, at most ₹25 lakh |
| Commuted pension | Fully exempt | One-third exempt if gratuity is also received, otherwise one-half |
| Monthly pension | Taxable as salary | Taxable as salary |
| Leave encashed while in service | Taxable | Taxable |
Gratuity
Government employees: death-cum-retirement gratuity is fully exempt. The central government ceiling on the gratuity itself has been ₹25 lakh since 1 January 2024 (see gratuity rules).
Employees covered by the gratuity law (the Payment of Gratuity Act, now part of the Code on Social Security): the exempt amount is the least of:
- the gratuity actually received;
- ₹20 lakh;
- 15/26 × last month's basic + DA × completed years of service, counting a part-year of more than six months as a full year.
Employees not covered: the least of the actual gratuity, ₹20 lakh, and half a month's average salary (basic + DA, averaged over the last 10 months) for each completed year, ignoring part-years.
The ₹20 lakh is a lifetime limit across all employers. Gratuity paid to the family after an employee's death is not taxable in their hands.
Leave encashment
Encashing leave while still in service is taxable as salary. At retirement or resignation, central and state government employees get the full amount tax-free. Everyone else gets the least of:
- the amount actually received;
- ₹25 lakh (raised from ₹3 lakh from 1 April 2023);
- 10 months' average salary (basic + DA, averaged over the last 10 months);
- the cash value of the leave to your credit at the average salary, counting no more than 30 days of leave for each completed year of service.
The ₹25 lakh is also a lifetime limit, and leave encashment paid to the family after death is not taxable. For how the amount itself is worked out, see leave encashment.
Commuted pension
Commuting means taking part of your pension as a lump sum now in exchange for a smaller monthly pension. For government employees, and employees of local authorities and corporations set up by a central or state Act, the lump sum is fully exempt. For others:
- if you also receive gratuity, one-third of the commuted value of your full pension is exempt;
- if you do not receive gratuity, one-half is exempt.
The monthly pension you keep is taxed as salary, with the standard deduction. See pension commutation and tax on pension.
Private employee. Rajesh retires after 30 years and 4 months and is covered by the gratuity law. His last basic + DA is ₹90,000 a month and his 10-month average is ₹88,000.
Gratuity: 15/26 × ₹90,000 × 30 = ₹15,57,692 (4 months is less than six, so 30 years count). If that is what he receives, all of it is exempt, because it is under ₹20 lakh.
Leave encashment: he has 300 days of leave to his credit (well within the cap of 30 days for each year of service) and receives ₹9,00,000. The exempt amount is the least of ₹9,00,000, ₹25,00,000, 10 × ₹88,000 = ₹8,80,000, and 300 days at the average salary = 300 × ₹88,000 ÷ 30 = ₹8,80,000. So ₹8,80,000 is exempt and ₹20,000 is taxable as salary.
If a lump sum pushes you into a higher slab
The taxable part of a gratuity or commuted pension is taxed in the year you receive it. If that pushes you into a higher slab, you can claim relief under section 157 of the 2025 Act (section 89 earlier) by filing Form 39 (earlier Form 10E). See section 89 relief, and estimate the amounts with the gratuity calculator and leave encashment calculator.