Leave Encashment Tax: When It Is Exempt and How Much You Can Save
Leave encashed while in service is fully taxable. At retirement or resignation, non-government employees get up to ₹25 lakh exempt under Section 10(10AA). Here is the formula with a worked example.
Leave Encashment Tax: Exemption Rules Under Section 10(10AA)
Leave encashment received while you are still employed is fully taxable as salary. Leave encashment received on retirement or resignation is exempt: fully for central and state government employees, and up to ₹25 lakh for everyone else under Section 10(10AA)(ii), subject to a four-part formula. The exemption is available under both the old and the new tax regime.
Is leave encashment taxable during service?
Yes. If you encash earned leave every year or when changing jobs mid-career while staying in employment, the amount is added to your salary income and taxed at your slab rate. You may claim relief under Section 89 (by filing Form 10E before your return) if the encashment relates to earlier years and pushes you into a higher slab.
How much is exempt at retirement or resignation?
For government employees (central and state), leave encashment on retirement is fully exempt.
For non-government employees, including PSU and private-sector staff, the exempt amount is the least of:
- ₹25,00,000 (raised from ₹3,00,000 with effect from 1 April 2023)
- 10 months' average salary
- Cash equivalent of unutilised earned leave, counting at most 30 days per completed year of service
- Leave encashment actually received
Anything above the least of these is taxable as salary.
"Salary" here means basic pay plus dearness allowance (where it forms part of retirement benefits) plus commission as a fixed percentage of turnover. Average salary is the average for the 10 months immediately before retirement or resignation.
The ₹25 lakh limit is a lifetime limit. If you claimed ₹6 lakh on leaving an earlier employer, only ₹19 lakh remains for later exits.
Worked example
Meera resigns from a Bengaluru IT company after 12 years and 4 months.
- Basic + DA for the last 10 months: ₹1,20,000 per month, so average salary is ₹1,20,000
- Leave credited: 30 days per year. Leave balance at exit: 240 days
- Leave encashment received: ₹9,60,000
| Limit | Calculation | Amount |
|---|---|---|
| Statutory cap | Fixed | ₹25,00,000 |
| 10 months' average salary | 10 × ₹1,20,000 | ₹12,00,000 |
| Cash equivalent of leave | 240 days ÷ 30 × ₹1,20,000 (leave counted at max 30 days × 12 completed years = 360 days, so 240 is within limit) | ₹9,60,000 |
| Actually received | ₹9,60,000 |
Exempt: ₹9,60,000. Taxable: nil. In the 30% slab, that saves her roughly ₹3 lakh in tax plus cess.
Note that only completed years count. The extra 4 months are ignored.
What about encashment received by legal heirs?
Leave encashment paid to the family of an employee who dies in service is not taxable in the hands of the legal heirs, as clarified by CBDT. It is not treated as salary of the deceased either.
Common mistakes in claiming the exemption
- Employer did not apply the exemption in Form 16. You can still claim it in your ITR. Show the full amount as salary and claim the exempt portion under Section 10(10AA) in the exempt allowances schedule.
- Using gross salary instead of basic + DA to compute average salary. HRA and special allowance are excluded.
- Forgetting the lifetime cap when you had a previous exit with an exemption.
- Claiming exemption on mid-service encashment. That is always taxable.
How is it shown in the ITR?
In ITR-1 or ITR-2, under Salary, enter the gross leave encashment in salary, then select "Sec 10(10AA) Earned leave encashment" as an exempt allowance and enter the exempt amount. Keep your final settlement statement and leave balance letter in case of a notice.
How SP & SC helps
We compute the exemption from your full-and-final statement, claim any refund your employer's TDS missed, file Form 10E for Section 89 relief where it helps, and reply to mismatch notices. See our income tax filing service or ask for a fixed-fee quote.
Frequently asked questions
Is leave encashment exempt under the new tax regime?
Yes. Section 10(10AA) is among the exemptions still allowed under Section 115BAC.
Is leave encashment on resignation exempt, or only on retirement?
Both. The courts and CBDT treat resignation as "retirement" for this purpose, so a private-sector employee resigning gets the same exemption.
Is the ₹25 lakh limit per employer?
No. It is a lifetime limit across all employers.
Is leave encashment part of gratuity?
No. They are separate. Gratuity is exempt under Section 10(10) with its own ₹20 lakh limit.
My employer deducted TDS on the full amount. How do I get it back?
Claim the exemption in your ITR. The excess TDS comes back as a refund after processing.
Written by
SP & SC Editorial
Editorial team at SP & SC Legal and Taxation Services — practising advocates, chartered accountants, and company secretaries publishing hands-on guidance from live client files.
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