Taxation of Leave Encashment – Exemptions and Tax Calculation


Leave Encashment after retirement taxation

Is leave encashment taxable? Read on to know.

During the service of an employee, he will given different kinds of leaves to be availed like earned leave, medical leave, casual leave etc. However all of them will either lapse or can not be converted into cash (encashment). Earned leaves are the only type of leaves which get accumulated over the service and also which can be encashed during the service or at the time of retirement from service (subject to a maximum limit). This is why earned leaves are mostly saved by salaried employees for the sake of future encashment. But won’t the leave encashment attract tax as you are getting income from such encashment? Let’s discuss it in detail:

Tax implications of leave encashment:

Taxation on the leaves encashed is dealt by section 10(10AA) of the Income Tax Act, 1961. The taxability of the leaves encashed depends on the time of encashment of such leaves. If leaves are encashed after the retirement (i.e., at the time of retirement), the following is the schema of taxation for two different categories of employees: 1. Government employees which include central as well state government employees and 2. Private employees

The above schema is self-explanatory. The leave encashment of government employees at the time of the retirement is completely exempt from tax. However, for private employees such tax exemption is limited to the least of the following:

Tax Exemption for private employees on leave encashment after retirement is limited to least of
a. Average monthly salary of last 10 months
b. Leave encashment actually received
c. Cash equivalent of unutilized earned leave – taking 30 days per year of actual service*
d. The maximum amount specified by the Government (Rs.3,00,000/- )

*The cash equivalent of the leave to the credit of the employee at the time of the retirement can be calculated using the following formula:

[(((CY*LC)-LA)/30)*S]

Where CY: Number of completed years of service
LC: Leaves credited per year subject to maximum limit of 30 per year
LA: Leaves availed during the service by the employee
S: Average salary of the employee for last 10 months

Points to be noted:

  • >> Leave encashment received during resignation or voluntary retirement has the same impact of taxation as that of leave encashment at the time of retirement.
  • >> Leave encashment received by legal heir of the deceased employee is FULLY EXEMPT from tax.
  • >> In case an employee received leave encashment from two or more employers in the previous year, then cumulative amount of the tax exemption from salary due to leave encashment cannot exceed Rs.3,00,000 in that year.
  • >> The maximum tax emption of Rs. 3 lakh available to the private employee pertains to his lifetime. This means that in his entire life time only once he can claim exemption of Rs. 3 lakh on leave encashment. If one claims Rs 3 lakh at the time of retirement from a job and suppose subsequently he joins a new job. He cannot claim the tax exemption at the time of retirement from his second job.

Leave encashment during the tenure of service:

Any earned leave or leaves encashed during the tenure of service of an employee are FULLY TAXABLE irrespective of the employer i.e., whether private or government. Hence tax implications in this case are straightforward and simple. If you have received any leave encashment during the tenure of your service you should show it under the Income From Salary while filing the Income Tax Return.

Do you have any queries regarding taxation of your leave encashment ? Do let us know through comments and we will try to answer them.

If you have just got retired from your job? You should also know about tax implications of your gratuity received from your employer. Do read our post on Gratuity Tax calculator and tax exemptions to know more about it.

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