When you leave a job after a long tenure, you receive several payouts that look like one big pile of money. They are not treated equally by the Income Tax Department. Getting this wrong in your ITR can mean paying more tax than required - or attracting a scrutiny notice.

Here is how each component is taxed.

Gratuity

Gratuity is a defined benefit payment from your employer, calculated as 15 days of last drawn salary for every completed year of service.

Formula: Gratuity = (Last drawn salary x 15 x years of service) / 26

Where “salary” = basic + DA for most purposes.

Tax treatment:

The taxability depends on whether you are covered by the Payment of Gratuity Act, 1972 (applicable to organizations with 10+ employees).

Category Exemption Limit
Government employees Fully exempt (no cap)
Employees covered by Gratuity Act Least of: (a) Rs. 20 lakh, (b) Actual gratuity received, (c) 15/26 x last basic+DA x years
Employees not covered by Gratuity Act Least of: (a) Rs. 20 lakh, (b) Actual gratuity received, (c) Half month’s average salary x years

For most private sector employees covered under the Act, the Rs. 20 lakh limit means gratuity up to Rs. 20 lakh is fully tax-exempt. Above Rs. 20 lakh, the excess is taxable as salary income.

If you receive gratuity from multiple employers across different jobs, the total exemption in a lifetime is capped at Rs. 20 lakh.

Leave Encashment

Leave encashment is the cash you receive for unused earned leave at the time of resignation, retirement, or death.

At retirement or death:

  • Government employees: Fully exempt under Section 10(10AA)(i)
  • Other employees: Exempt up to Rs. 25 lakh (enhanced from Rs. 3 lakh in 2023)

At resignation (before retirement):

This is where many people get surprised. Leave encashment during service (when you resign and the company pays for accumulated leaves) is taxable - but with an exemption calculated as:

Exemption = Least of: (a) Rs. 25 lakh, (b) Actual amount received, (c) Average monthly salary x 10, (d) Cash equivalent of leave that stands to your credit (limited to 30 days per year of service)

In practice, most corporate employees receive leave encashment well within the Rs. 25 lakh limit and it is substantially exempt.

On termination or layoff: Treated as resignation - same calculation applies.

Performance Bonus / Joining Bonus / Retention Bonus

This is the simplest category: all bonuses are fully taxable as salary income with zero exemption.

Performance bonus, annual bonus, joining bonus, retention bonus, signing bonus - every rupee is added to your gross salary and taxed at your marginal rate.

There is no tax planning possible here. The only mitigation is if the bonus falls in a fiscal year when your total income is lower (e.g., you resigned mid-year), which might push you into a lower slab.

If you received a joining bonus with a clawback clause (common in senior roles) and you returned it, the returned amount can be claimed as a deduction in the year of return.

Ex-Gratia Payments

Ex-gratia (voluntary payment made without legal obligation) is fully taxable. It is different from gratuity. Even if your employer calls it a goodwill payment or recognition payment on exit, if it does not meet the legal definition of gratuity, it is taxable.

Compensation for Voluntary Retirement (VRS)

VRS amounts under a government-approved scheme are exempt up to Rs. 5 lakh under Section 10(10C). Amounts above Rs. 5 lakh are taxable. This applies to government employees, PSU employees, and companies with approved VRS schemes.

Reporting in ITR

All these amounts must be reported in ITR-1 (or ITR-2, depending on your income sources) under Schedule S (Salary Income):

  • Gratuity: Enter gross amount received; the exempt portion flows from Form 10E or Schedule EI
  • Leave encashment: Similar - enter total, claim exemption
  • Bonus: Add to gross salary - there is no separate schedule; it reflects in Form 16

Your Form 16 from the employer should reflect the TDS deducted on each component. If TDS was not deducted correctly (common when you leave mid-year and no TDS was calculated on gratuity), you are still responsible for the tax.

Practical Example

Employee leaves after 10 years of service:

Component Amount Received Taxable Amount
Gratuity Rs. 8 lakh Nil (within Rs. 20 lakh exemption)
Leave encashment Rs. 4 lakh Nil (within Rs. 25 lakh exemption, assuming calculation check passes)
Performance bonus Rs. 3 lakh Rs. 3 lakh (fully taxable)
Notice pay (paid by employee) Rs. 1 lakh Deductible from income (it is an expense incurred to earn salary)

Total taxable from this exit: Rs. 3 lakh at applicable slab rate.

Bottom Line

Gratuity is largely tax-free up to Rs. 20 lakh, leave encashment up to Rs. 25 lakh at retirement, but every rupee of bonus is taxable without any exemption. Do not let your company’s HR deduct TDS on gratuity unless the amount exceeds the exemption limit. Verify your Form 16 carefully in the year of exit. And if you receive multiple components at once, report all of them correctly in ITR - do not club them together or ignore the smaller items. +++