Leave Encashment: Tax Exemption, Calculation Formula, and Example (FY 2025–26)
Many salaried individuals accumulate paid leaves over their employment period. When such leaves remain unused, employees often have the option to either carry them forward or encash them—i.e., convert them into monetary compensation.
But what are the tax implications of this encashment? Can you claim any exemption? This guide answers it all—explaining leave encashment, tax treatment, exemptions under Section 10(10AA), and calculation with example.
✅ What is Leave Encashment?
Leave encashment means receiving money in exchange for unutilized paid leaves. These are the leaves accrued by an employee during service, but not availed.
At the time of retirement or resignation, employees often receive a lump sum for these leaves. This payment is either fully or partially taxable, depending on the employer type and applicable tax rules.
🗂️ Types of Leaves Eligible
Different organisations have different leave policies. Common categories include:
- Casual Leave – Short leaves for personal matters; encashment depends on employer policy.
- Earned/Privilege Leave – Can be accumulated and often eligible for encashment.
- Medical Leave – Typically allowed for health issues; usually not encashable.
- Holiday Leave – Paid public holidays; not encashable.
- Maternity Leave – Available to women employees; not eligible for encashment.
- Sabbatical Leave – For learning/upskilling; usually reimbursed but not encashable.
🧾 Taxation on Leave Encashment
Leave encashment can be received:
- During employment, or
- At the time of retirement/resignation.
🔹 1. During Service
If leave encashment is received while still in service, it is fully taxable as part of “Income from Salary”.
🔹 2. At the Time of Retirement or Resignation
| Recipient | Taxability |
|---|---|
| Central or State Govt Employees | Fully Exempt |
| Non-Govt Employees | Partially Exempt u/s 10(10AA)(ii) |
| Legal Heirs of a Deceased Employee | Fully Exempt in their hands |
📊 Leave Encashment Exemption – Calculation for Non-Govt Employees
👉 Formula for Exemption [u/s 10(10AA)(ii)]
Least of the following is exempt:
- ₹25,00,000 – Max amount notified by Govt
- Actual amount received
- 10 months’ average salary (Basic + DA + % Commission on sales)
- Salary per day × Unutilized leave (max 30 days/year × completed service years)
📌 Example – Leave Encashment Calculation
Case:
- Mr. A retires after 15 years of service.
- Annual paid leaves: 35 days
- Total leaves accrued: 525 days
- Leaves used: 200 days
- Leaves left: 325 days
- Monthly salary (Basic + DA): ₹33,000
- Leave encashment received: ₹3,57,500
Step-by-step Computation:
| Particulars | Amount (₹) |
|---|---|
| Leave encashment received (A) | 3,57,500 |
| Exemption u/s 10(10AA) (Least of): | |
| a) Govt notified limit | 25,00,000 |
| b) Actual amount received | 3,57,500 |
| c) 10 months avg salary | 3,30,000 |
| d) ₹1,100 × (30 × 15 – 200) | 2,75,000 |
| Exempt amount (B) | 2,75,000 |
| Taxable amount (A – B) | ₹82,500 |
⚠️ Important Points
- If received from multiple employers in the same FY, exemption limit stays ₹25 lakhs in total.
- Exemption applies under both old and new regimes.
- Salary for calculation includes Basic + Dearness Allowance + Turnover-based Commission.
💡 ITP Insight
While planning leave encashment, consider:
- Your employer’s policy
- Projected tax slab at time of encashment
- Inflation vs value of money now vs at retirement
Strategic leave encashment can lead to smart tax savings—especially with proper documentation and planning.
