income tax

Published on 11 April 2025

Understanding Leave Encashment: Tax Implications and Exemption Limits

Understanding Leave Encashment and Its Tax Implications

Leave encashment is a vital employee benefit for salaried individuals in India, particularly during retirement or resignation. Recent changes in tax legislation necessitate a clear understanding of the tax-exempt portions of leave encashment and the process for claiming these exemptions.

What is Leave Encashment?

Leave encashment is the financial gain provided for unused earned leave at the time of retirement, resignation, or during the tenure of employment with the company. Although various leaves (such as casual or sick leave) are forfeited if not utilized, earned, privilege, or annual leave can usually be carried forward and encashed.

Tax Treatment of Leave Encashment

Section 10(10AA) of the Income Tax Act, 1961

  1. Encashment of Leave While in Service
  • Entirely taxable for public and private sector employees.
  • Considered as part of "Salary" for taxation purposes.
  1. Encashment of Leave at Resignation/Retirement
    • Government Employees
      • Completely exempt from tax (Central and State government employees).
    • **Non-Government Employees

  • Exemption limit set at the lowest of the following parameters, according to Section 10(10AA)(ii):

  • Actual leave encashment taken - ₹25,00,000 (from 1 April 2023 onwards, as specified in CBDT Notification No. 31/2023) - Average salary for the last 10 months × 10

  • Value of encashment of unused leave (up to 30 days of leave for each year of service × average of salary for the last 10 months)

  • The amount in excess of the exemption is taxed as salary.

Calculation of Leave Encashment Exemption

CriteriaAmount (Example)
Actual leave encashment received₹18,00,000
Maximum legal limit₹25,00,000
10 months' average salary₹12,00,000
Cash for unutilized leave (max 30 days/year) × average salary₹10,00,000
Allowed Exemption (lowest of above)₹10,00,000
Taxable Amount₹8,00,000

Important Points to Remember

  • The ₹25 lakh exemption limit is aggregative over all employers and is a one-time limit.
  • Leave encashment taken by legal heirs in case of an employee's death is exempt from tax.
  • Section 89 relief is available for any tax paid on leave encashment.
  • Employers have to deduct TDS on any taxable leave encashment.
  • Report any leave encashment under "Salaries" in your Income Tax Return (ITR).

Frequently Asked Questions (FAQs)

  • What is the leave encashment exemption limit for non-government employees in 2025?

    • The limit is ₹25,00,000, as notified in CBDT Notification No. 31/2023, effective from 1 April 2023.

  • Is leave encashment taxable for government employees?

    • No, leave encashment is exempt for Central and State government employees.

  • How is leave encashment average salary computed?

  • The average salary consists of basic salary, dearness allowance (if included in retirement benefits), and commission (if based on percentage of turnover) averaged for the previous 10 months preceding retirement.

  • Can exemption from leave encashment be claimed from all employers?

    • Yes, but total exemption is ₹25 lakh only in a person's lifetime.

  • Is leave encashment availed during service exempt?

  • No, it is taxed fully for all.

Conclusion

As the leave encashment exemption limit has been raised to ₹25 lakh, the government employees will benefit with increased tax relief during retirement. It is important to know the rules' provisions and exemption calculation practices in effective financial planning and tax optimization.

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