Leave Encashment Tax Exemption: What Salaried Employees Must Know
- Rashmita Choudhary
- Dec 14, 2025
- 7 min read
Introduction
When employees join a company, they are eligible for a number of advantages. One of them is a paid leave benefit that employees can use as a leave encashment in the event that it is not used. The possibility of exchanging unused leaves for cash provides employees with an additional safety net. The employer permits the employee to roll over any unused leave to the following year in such a situation. Instead of taking vacation time, employees can choose to be compensated for any unused leave. The employee is responsible for paying taxes on any monetary reward. As a result, leave encashment has tax ramifications that vary depending on a number of criteria, including whether a person works for the government or the private sector. Tax exemptions can be availed on leave encashment under the provisions of the Income Tax Act.
Table of Contents
What is Leave Encashment?
Receiving monetary compensation in exchange for the employee's unused paid time off during their employment is known as "leave encashment." Every salaried individual is entitled to a minimum amount of paid leave each year under labour law. Nonetheless, an employee is not required to use all of the leave to which he is legally entitled within a given year. In actuality, the majority of firms provide their workers the choice to carry over unused paid time off. When an employee retires or resigns from the company, they will always have an accumulated unused leave balance. This requires the business to make up for the employees' unused paid time off. The term "leave encashment" is more commonly used to describe this idea.
Types of Leaves for Salaried Employees
A company's leave policy lists the many kinds of leaves. Every company has different leave policies. The sorts of leaves that employees often have access to are as follows:
Earned leave: If an employee gives the authorities advance warning, they may utilise earned leave. After a certain amount of time, these leaves are eligible for encashment. Every organisation has a different policy.
Casual leave: You can take seven to ten days of casual leave. These leaves are available to employees for personal reasons. The way that this leave is cashed differs depending on the company.
Holiday leave: Employees are granted holiday leave, and no pay is withheld. Each company has a different maximum number of holiday leaves.
Medical leaves: Employees must notify their employer if they are unable to carry out their responsibilities to the company because of a health issue. The maximum amount of medical leaves that can be taken varies depending on the company.
Maternity leave: Only female employees are eligible for maternity leave, which can last anywhere from 12 to 26 weeks of pregnancy. An extension may be requested by an employee, but no compensation will be given during that time. Nevertheless, it is not possible to encash these leaves.
Sabbaticals: Workers can take time off to develop their skills and broaden their knowledge. They can sign up for a course, and the company will pay for those leaves during that time.
Leave Encashment Taxation
Employees who get leave encashment are subject to taxation at the time of receipt. The following two situations qualify for leave encashment:
Leave Encashment Received During Service
The amount of leave encashment that an employee receives while working is completely taxable and is included in "Income from Salary." However, Section 89 of the Income Tax Act allows you to receive some tax benefits. To claim the tax reduction for salary arrears on leave encashment, you must complete Form 10E. This form can be completed and submitted electronically via the income tax portal.
Leave Encashment Received After Resignation or Retirement
Employees can cash their accrued paid leave when they retire or resign. The type of organisation determines how this leave encashment is treated tax-wise.
Government Workers: Workers who are employed by federal or state governments are completely exempt from paying taxes on the encashment of their leave. This indicates that no tax deductions are made from the full amount of the leave encashment.
Workers in the Private/Non-Government Sector: Section 10(10AA) of the Income Tax Act provides a partial or full exemption on leave encashment for workers in the private or non-government sector. According to the Finance Budget 2024, the maximum ceiling is set at Rs. 25,00,000. Any sum over Rs. 25,000,000 will be subject to taxes.
Encashment of Leave for Legal Heirs: The legal heirs are entitled to receive the entire leave encashment sum on behalf of the deceased employee if they pass away prior to the employee's leave being cashed. Additionally, the amount received by the dead employee's lawful heirs will not be subject to leave encashment taxes.
Leave encashment received by
| Taxability
|
State and Central Government employees | Fully tax-exempt |
Non-government employees | Partly exempt and partly taxable. The exemption is based on the calculation specified in Section 10(10AA)(ii). |
Legal heir of a deceased employee | Fully tax-exempt Leave encashment amount received by the Legal heir of a deceased employee is fully tax-exempt in the hands of the legal heirs. |
Calculation of Taxable Leave Encashment using Exemption
The following formula is used to calculate the value of taxable leave encashment:
Leave encashment taxable= Leave encashment received - Exemption under Section 10(10AA)
Exemption under Section 10(10AA) is the least of the following:
Amount notified by the Government Rs. 25,00,000
Actual leave encashment amount
Average salary of the last 10 months
Salary per day for unutilised leave (considering a maximum of 30 days leave per year) for every year of service completed
Factors Affecting Leave Encashment Exemption
A number of criteria are considered while determining the leave encashment exemption for non-government employees. This is the detailed explanation.
Basic Salary: The main factor used to determine the exempt amount and the fixed portion of your pay.
Accumulated Leave: The entire unused paid leave days that qualify for leave encashment is known as accumulated leave. A maximum of 30 days of leave each year of service are taken into account for tax exemption reasons, and no more.
Dearness Allowance (DA): In order to account for inflation, DA is included in the computation if appropriate.
Commission (if applicable): Any recurring commission that is included in your pay is also taken into account.
Years of Service: The number of leave days for which you are eligible for the leave encashment exemption is largely dependent on how long you have worked for the company.
Illustration
Let's use an example to better comprehend the leave encashment exemption:
After 15 years of service, X is retiring. X was entitled to 35 days of paid leave annually from his employer, for a total of 525 days of leave throughout the course of his employment (35 * 15). X still has 325 days of unused paid leave after using 200 of those days. At the time of retirement, X was receiving Rs 3,57,500 as leave encashment based on the following formula:
Basic salary + 325 days * Rs. 1,100 (salary per day = Rs. 33,000/30 days) + DA of Rs 33,000 per month.
Particulars
| Amount (in Rs)
|
Leave encashment received | 3,57,500 |
Less: Exempt (lowest of the below) | 2,75,000 |
Least of the following: Amount notified by the Government Actual leave encashment Average salary for 10 months= Rs 33,000 * 10 months Rs 1,100 * (30 days * 15 completed years of service minus 200 days of utilised leave) | 25,00,000 3,57,500 3,30,000 2,75,000 |
Leave encashment taxable as ‘income from salary | 82,500 |
Conclusion
Particularly for an employee who retires or chooses to quit a company, leave encashment can offer a significant income boost. However, a systematic strategy is necessary to take advantage of tax benefits. Tax planning can be done by determining whether it is better to get a lump payment at the time of retirement or resignation or to encash leave annually, depending on an individual's salary and the employer's leave encashment policy. Before making a decision, one may also take the cost of inflation into account. Private sector workers benefit from exemptions under Section 10(10AA), whereas government employees are eligible for tax-free leave encashment. Seeking expert guidance guarantees a seamless procedure, enabling people to optimise savings and successfully manage tax ramifications.
Frequently Asked Questions
How is leave encashment computed?
For employees in the private sector, the computation takes into account the amount received, the government's maximum limit, the basic salary and DA for the previous ten months, and the product of daily salary and unused leave days (up to 30 per year) for each full year of service.
What is the exemption limit for leave encashment under Section 10(10AA)?
Taking into account any earlier tax exemptions granted under the same section in prior years, the income tax exemption under Section 10(10AA) cannot exceed Rs. 25 lakh.
How is leave encashment taxed for non-government employees post-retirement or resignation?
For non-government employees, leave encashment is both partially taxable and partially exempt, with the Income Tax Act's Section 10(10AA)(ii) standards governing taxes.
Can leave encashment be retained?
If the taxpayer is not facing any criminal charges or departmental enquiries at the time of retirement, leave encashment may be kept.
Is leave encashment subject to taxation upon resignation?
When leave encashment is received upon resignation, it is subject to taxation.
What are the tax implications if leave encashment is received by the heirs of a deceased?
If legal hires receive leave encashment, it is completely exempt.
Can all types of leaves be encashed?
No, not every kind of leaf can be cashed. It mostly depends on the kind of leave and the company's policy.
What is the maximum number of leaves that can be encashed?
Workers may cash their leaves in the next year, up to a maximum of 30 days of earned leave or 50% of earned leaves at credit, whichever is less.
Are leave encashment and leave salary the same?
One part of leave encashment is the leave salary, which is accrued over time and redeemed at a later time.
Will I get a tax exemption on leave encashment in the new tax regime?
Yes, under the new tax regime, leave encashment is exempt from taxes. The Income Tax Act’s Section 10(10AA) highlights the requirements for taking advantage of the leave encashment exemption.
Can I use the entire limit of Rs. 25,00,000 for leave encashment?
Yes, tax breaks up to Rs. 25,000,000 are available to non-government employees; however, this is the maximum amount and is only available under specific circumstances.
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