Tax Treatment of Leave Salary (Leave Encashment)

Leave salary, or leave encashment, refers to the payment an employee receives for unused leave days. Its taxability depends on when it is received (during service or at retirement/resignation) and the employee’s sector (government or private). Below is a detailed breakdown:

1. Tax Rules for Leave Salary

A.  Leave Encashment Received During Employment

• Fully taxableas part of “Income from Salaries” for all employees (government and private).
• No exemptionsapply unless relief is claimed under Section 89 (for arrears) by filing Form 10E.

B.  Leave Encashment at Retirement/Resignation

2. Calculation of Exemption for Private Employees

Formula:

Taxable Leave Salary = Total Leave Encashment – Exemption (least of 4 limits above)

Example:

• An employee retires after 20 years, with 400 unused leave days(max 30 days/year = 600 days eligible).
• Average salary (last 10 months):₹40,000/month
• Leave encashment received:₹5,00,000

Exemption Calculation:

1. ₹25 lakh(lifetime cap)
2. Actual encashment:₹5,00,000
3. 10 months’ salary:₹4,00,000
4. 30 days/year:(30 × 20) = 600 days – 400 utilized = 200 days × (₹40,000/30) = ₹2,66,667

Exempt Amount: ₹2,66,667 (least of above)

Taxable Amount: ₹5,00,000 – ₹2,66,667 = ₹2,33,333

3. Key Points

1. Lifetime Cap:The ₹25 lakh exemption is cumulative across all employers .
2. Salary Definition:Includes basic + DA + turnover-based commission .
3. New Tax Regime:Exemption under Section 10(10AA) applies in both old and new regimes .
4. Medical/Maternity Leaves:Not eligible for encashment in most cases .

4. Comparison of Tax Treatment

5. Reporting in ITR

• Taxable leave salarymust be reported under “Income from Salaries” in ITR-1/ITR-2.
• Form 10Emust be filed to claim relief under Section 89 (if applicable)