Have you ever come across the term ‘leave encashment’?
For salaried employees, leave encashment is a common concept. It essentially means that even unused leave can be converted into financial benefits.
Keep reading to understand what leave encashment is, how it is taxed, and how the calculation works.
What is Leave Encashment?
Under labor laws, every salaried employee is entitled to a certain number of paid leaves annually. However, not all employees use up their allotted leaves in a given year. Many organizations allow employees to carry forward unused leaves, leading to an accumulation over time.
When an employee resigns or retires, any unutilized paid leave must be compensated by the employer. This process is referred to as leave encashment.
Types of Leaves
Each company has its own leave policy, outlining different types of leave available to employees. While policies may vary, here are some common types of leave:
- Casual Leave – Typically granted for 7 to 10 days, casual leave is used for personal reasons. Whether these leaves can be encashed depends on company policy.
- Earned Leave (Privilege Leave) – Employees can avail of earned leaves with prior notice. These leaves may be eligible for encashment after a specific period, based on company rules.
- Medical Leave – If an employee is unable to work due to illness, medical leave can be taken. The number of paid medical leaves differs across organizations.
- Holiday Leave – These are company-declared holidays where employees receive paid time off. The number of holidays depends on company policy.
- Maternity Leave – Available exclusively to female employees, maternity leave ranges from 12 to 26 weeks during pregnancy. While an extension can be requested, extended leave may not be paid. These leaves cannot be encashed.
- Sabbatical Leave – Employees can take sabbaticals to enhance their skills through courses or professional development programs. In some cases, employers may reimburse the leave period.
Understanding leave encashment can help employees maximize their benefits and plan for tax implications. Would you like to know how leave encashment is calculated and taxed? Stay tuned for more insights!
Taxation of Leave Encashment
Leave Encashment Received During Employment
The taxation of leave encashment depends on when it is received. If an employee encashes leave while still employed, the entire amount is fully taxable as part of Income from Salary.
However, relief can be claimed under Section 89 of the Income Tax Act. To avail of this benefit, employees must fill out Form 10E and submit it online through the income tax portal. This helps in reducing the tax burden on arrears related to leave encashment.
Leave Encashment at the Time of Retirement or Resignation
In certain cases, leave encashment received at the time of retirement or resignation may be partially or fully exempt from tax. The tax treatment depends on the category of the employee:
| Employee Category | Tax Treatment |
| State and Central Government Employees | Fully tax-exempt |
| Non-Government Employees | Partially exempt under Section 10(10AA)(ii); the remaining amount is taxable. |
| Legal Heir of a Deceased Employee | Fully tax-exempt in the hands of the legal heir. |
Leave Encashment Calculation
For non-government employees, the leave encashment exemption is calculated using the following formula:
Exemption Limit Increased: The limit for tax exemption has been raised from ₹3 lakh to ₹25 lakh.
| Particulars | Amount (₹) |
| Leave Encashment Received (A) | XXXX |
| Less: Exemption under Section 10(10AA) – Least of the following (B): | XXXX |
| (i) Government Notified Limit (₹25,00,000) (C) | 25,00,000 |
| (ii) Actual Leave Encashment Received (D) | XXXX |
| (iii) Average Salary of Last 10 Months (E) | XXXX |
| (iv) Salary per Day × Unutilized Leave (Maximum 30 Days per Year) × Completed Years of Service (F) | XXXX |
| Taxable Leave Encashment: (A) – (B) | XXXX |
Understanding the taxation of leave encashment helps employees plan their finances better. Need assistance with leave encashment calculations? Consult a tax expert for personalized guidance!
