Taxation of Gratuity in Kenya: 2026 Guide to KRA Rules & Exemptions

If you are a contract employee or approaching retirement in Kenya, there is good news regarding your terminal benefits. Following the implementation of the Finance Act 2025, the Kenya Revenue Authority (KRA) has radically changed how gratuity is taxed.

For years, gratuity was treated as part of your employment income and subject to heavy PAYE deductions. Today, a significant portion of that money can stay in your pocket.

The Golden Rule: Gratuity earned after July 1, 2025, is now fully 100% exempt from income tax in Kenya.

1. The Two-Tier Tax System for Gratuity

Because the law changed mid-way through 2025, KRA applies a "split" treatment based on when the money was earned, not when it is paid.

• Portion Earned Before July 1, 2025: This remains taxable. Even if you receive the payment today in 2026, the years you worked before the cut-off date are still subject to tax.
• Portion Earned After July 1, 2025: This is tax-exempt. Any gratuity accrual relating to service from this date onwards is paid to the employee in full without PAYE deductions.

2. How Taxable Gratuity is Calculated (The "Spread Back" Rule)

For the taxable portion (pre-July 2025), KRA does not tax the whole lump sum in a single month. Instead, it uses a spread-back method to prevent you from being pushed into a higher tax bracket unnecessarily.

Period of Service	Tax Treatment
Prior 4 Years	Allocated to the specific years it was earned and taxed at those years' rates.
Beyond 5 Years	Any balance remaining is bundled and taxed as income of the 5th year.

Note: Employers must consolidate this with your previous salary for those years and only pay the difference in tax.

3. Public vs. Private Sector Gratuity

The rules vary slightly depending on your scheme:

• Public Pension Schemes: Gratuity paid from the Consolidated Fund became exempt earlier (effective December 2024).
• Private Schemes: If you "Contract Out" or pay your gratuity into a registered pension scheme, you can enjoy further tax reliefs (up to KES 30,000 per month) even for the older taxable portions, provided you hadn't already exhausted your pension limits for those years.

4. Practical Example

Imagine an employee completes a 6-year contract in December 2026 and is entitled to a KES 1,200,000 gratuity.

• Years 2021 to June 2025 (4.5 years): Let's say KES 900,000 relates to this period. This amount is taxable and will be spread back over those years.
• July 2025 to December 2026 (1.5 years): KES 300,000 relates to this period. This amount is 100% Tax-Free.