Leave Encashment is a benefit provided by employers that allows employees to receive a monetary equivalent for unused leave days. Instead of losing out on leaves that were not taken, employees can convert these into cash, subject to many company policies. It is an important component of employee compensation and is often seen as a financial cushion during retirement or resignation.
Importance of Leave Encashment for Employees
Leave encashment plays a vital role in financial planning. For many employees, especially those nearing retirement, encashed leave acts as a substantial financial benefit.
It encourages employees to save their leaves rather than exhaust them unnecessarily.
Additionally, during unforeseen circumstances like layoffs or voluntary resignation, leave encashment offers a monetary fallback.
When Can Leave Encashment be Claimed?
Leave encashment can typically be claimed under the following circumstances:
- At the time of retirement (superannuation or voluntary retirement)
- During resignation or termination of employment.
- During service (in case the company offers mid-service encashment policies)
It’s important to note that not all organizations offer leave encashment during service; it varies based on internal HR policies.
Taxability of Leave Encashment
The taxability of leave encashment depends on when it is received and the type of employer:
Government Employees
Leave encashment received at the time of retirement is fully exempt from Income Tax.
Non-Government Employees
Leave encashment is partially exempt under Section 10(10AA) of the Income Tax Act, subject to certain limits.
Leave Encashment During Service
Fully taxable in the hands of the employee, irrespective of the employer.
Leave Encashment in Government vs. Private Sector
| Government Sector | Private Sector |
| Employees enjoy full tax exemption on leave encashment received upon retirement. | Employees get exemption up to certain limits, and the balance is taxable. The current maximum exemption limit under Section 10(10AA) for private employees is INR 25 Lakhs. |
Thus, the sector in which an employee works significantly affects the tax treatment of their leave encashment amount.
Formula for Calculating Leave Encashment
The basic formula to calculate leave encashment is:
Leave Encashment = (Number of Earned Leaves x Monthly Salary) ÷ 30
Where:
Number of Earned Leaves = Total unused eligible leaves
Monthly Salary = Basic Salary + Dearness allowance + Commission based on fixed percentage of turnover
30 = assumed average number of days in a month
Example
If an employee has earned leaves and a monthly salary of INR 60,000, the leave encashment would be: (120 x 60,000)÷ 30 = INR 2,40,000
Tax Exemptions under the Income Tax Act
According to Section 10(10AA), the least of the following four amounts is exempt from tax for non-government employees:
- Actual amount of leave encashment received.
- INR 25 Lakhs
- 10 months Average salary [Salary = Basic Salary + DA + Commission (if applicable)]
- Cash equivalent of unutilized leave calculated based on 30 days leave per year of service
Note:
- Any amount over the exempted limit will be added to the taxable income of the individual and will be taxed as per the applicable tax slabs.
- For government employees, leave encashment is exemptonly when they receive it at the time of retirement. Thus, if they receive it during the period of service, it is fully taxable.
- For non-government employees, leave encashment is never fully exempt. If they receive it at the time of retirement, it is partially taxed as explained above. If they receive it during the period of service, it is fully taxed.
Points to Remember While Claiming Leave Encashment
- Always check your company’s leave policy regarding the maximum number of allowed leaves for encashment.
- Maintain proper documentation and obtain a certificate if encashment is part of retirement benefits.
- Make sure the salary components used for calculations are correct as per Income Tax definitions.
Conclusion
Leave encashment is a valuable benefit that rewards employees for their commitment and service. Whether received during employment, at resignation, or upon retirement, it provides financial support and incentives for disciplined leave management.
However, understanding the calculation method, tax rules, and sector specific exemptions is crucial to fully benefit from this entitlement. Proper planning and awareness ensure that employees maximize their benefits while minimizing their tax liabilities.
Pro Tips
Always differentiate between “during service” and “at retirement” when calculating tax on leave encashment.
- During service = Fully Taxable
- At retirement (Govt employees) = Fully Exempt
Plan your leaves wisely before retirement!
- Accumulating more unused eligible leaves can help maximize your tax-free leave encashment amount — especially if you’re nearing retirement.
FAQs
Ans. Yes, leave encashment received during service is fully taxable, even if you change jobs.
Ans. No, the exemption under Section 10(10AA) can be claimed only once in a lifetime for private sector employees.
Ans. No, only basic salary, dearness allowance, and fixed turnover-based commission are considered for leave encashment.