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Leave Encashment or leave Salary
(Section 10(10AA) of the Income Tax Act)

Leave encashemnent is a facility provided by employers to its employees to get paid in cash for their accumulated leaves. Paid leaves can be accumulated and encashed either during employment or at the time retirement or on resignation from employment.
 

Rules of Taxability of Leave Encashment

  • Leave Encashed during the employment
Fully Taxable - when Leaves are encashed during the employment, the amount received is fully taxable for both government and non government employees
  • Leave encashment at the time of retirement or on resigning from employment
For Central & State Government Employees leave encashment on retirement and resignation is not taxable at all - Fully exempt
For non Government Employees least of the following will be exempt-
    • Amount as specified by Central Government - Presently 3,00,000 is specified
    • 10 months salary (on the basis of average salary of last ten months)
    • Actual amount of leave encashment
    • Cash equivalent of the unutilised paid leaves
(Calulations are explained with example at the end of the article )
  • Leave Encashment on termination from employment will be fully taxable.
  • Leave encashment received by Legal Heirs of a deceased employee will be fully exempt.

Type of Employment explained
  • Government Employess - State Government & Central Government Employees
  • Non government Employees - Employess of all private companies and PSUs. (Public Sector Employees are also treated as non Government Employees)
Important Points
  • Salary for calculation of exemption will be average salary of last 10 months of employment and will include basic salary + DA + Commission (based on fixed % of turnover).
  • Employees are entitled for maximum 30 days of leave per year as paid leave for each completed year of service .
  • In case multiple job switches, 3,00,000 will be the overall limit considering all employments. If 1,00,000 leave encashment was exempt at first resignation then in future balance 2,00,000 will be considered for exemption.
Example-
Mr. Ramgopal retired after completing 20.3 years of service. Earned leave remaining to his credit were of 340 days. He was enitled for 32 days of earned leave per year. During the employment he had encashed 300 of earned leaves. His salary at the time of retirement was 45,000.

Leave Encashment Exemption amount will be 3,00,000 as calculated below.

Least of the following will be exempt-

Leave Encashment Received = 340* 1500
5,10,000
(Average salary per day = 45000/30=1500)

Government Specified limit
3,00,000
10 months Salary = 10* 45000
4,50,000
Cash equivalent of leaves in credit = 300*1500 4,50,000
Completed years of service = 20
Max allowed paid leave per year = 30
Total Leaves entitlement = 20*30 = 600
Leaves already encashed = 300
Leaves entitled for encashment on retirement = 600-300 = 300
( this calculation will be done on the basis of maximum leaves allowed per year as per law ie. 30 days per year)

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