Leave encashment means getting money in exchange for unused leave days. If you have saved up paid leaves at your job and don’t use them, your employer may pay you for those days when you leave the job or retire.
Think of it like this:
Imagine you had 30 days of leave left, but you didn’t take them. When you quit or retire, your company says, “Here’s the salary for those 30 days.”
Is Leave Encashment Taxable?
Yes – but only partly.
Some portion of this money is tax-free under Section 10(10AA) of the Income Tax Act, depending on:
- Whether you work in the government or private sector
- If you’re retiring, resigning, or leaving the job
Tax Rules for Government Employees
If you work for the Central or State Government, your entire leave encashment is fully tax-free, no matter how much it is.
Tax Rules for Private Sector Employees
If you work in the private sector, the leave encashment amount is partly tax-free, and the rest is taxed. You can get exemption on the lowest of the following four:
- Actual leave encashment received
- ₹3,00,000 (maximum limit set by the government)
- 10 months’ average salary before leaving
- Cash equivalent of leave balance, up to 30 days leave per year of service
Simple Example:
Let’s say Raj works at a private company. He retires with 240 days (8 months) of unused leave. His average monthly salary is ₹50,000.
- Actual leave encashment: ₹4,00,000
- 10 months’ salary: ₹5,00,000
- Leave for 30 days per year of 20 years = 600 days. He used 360 days, so 240 days left = 8 months = ₹4,00,000
- Maximum allowed by law: ₹3,00,000
Tax-free amount = ₹3,00,000 (the lowest of the above)
Remaining ₹1,00,000 is taxable
Few More Points:
- The ₹3 lakh exemption is a lifetime limit. If you’ve claimed it once, you can’t claim again.
- If you get leave encashment while still working, it’s fully taxable.
- Always ask for a salary certificate or breakup to calculate the exact exempt amount.
Final Thoughts
Leave encashment is a helpful bonus when leaving your job or retiring. Section 10(10AA) offers a tax relief, especially for long-serving employees. If you’re in the private sector, keep track of your leave balance and salary to make the most of this benefit.
