Leave encashment can provide a sizeable payout at retirement. But its tax treatment depends on when the amount is received and whether the employee works for the government or the private sector.
For Assessment Year (AY) 2026-27, the exemption is available under Section 10(10AA) of the Income-tax Act.
Leave encashment received during service is generally fully taxable. Benefits received on retirement, resignation or superannuation may qualify for exemption.
Leave encashment received during service
Any leave encashment received while an employee is still in service is treated as salary income.
The entire amount is taxable.
Government employees get full exemption
According to the Income-tax Act, Central and State Government employees enjoy complete tax exemption on leave encashment received at the time of:
- Retirement
- Superannuation
- Resignation
- Any other cessation of service
The entire amount received towards unutilised earned leave is exempt from tax.
Tax exemption for private-sector employees
For private-sector employees and other non-government employees, the exemption is available subject to limits.
According to CA Dr Suresh Surana, the exempt amount will be the least of the following:
- Actual leave encashment received
- Rs 25 lakh, the maximum monetary ceiling
- Average salary for the 10 months immediately preceding retirement
- Cash equivalent of unutilised earned leave calculated on the basis of the average salary of the last 10 months
Any amount exceeding the exempt limit becomes taxable.
Restriction on leave accumulation
For calculating the exemption, leave accumulation is capped.
Only 30 days of earned leave for each completed year of service with the employer from whom the employee retires can be considered.
Any leave accumulated beyond this limit is ignored while computing the exemption.
Is the exemption available under the new tax regime?
Yes.
According to CA Dr Suresh Surana, the exemption under Section 10(10AA) continues to be available under both:
- The old tax regime
- The new tax regime under Section 115BAC
The new regime does not withdraw the benefit.
How to report leave encashment in ITR
Taxpayers should disclose the amount under Schedule S (Income from Salary).
The amount should first be included in gross salary.
Eligible exemption can then be claimed under:
“Less: Allowances to the extent exempt under section 10.”
Documents employees should keep
Employees claiming exemption should retain supporting records.
These include:
- Form 16 issued by the employer
- Salary breakup or computation sheet showing leave encashment
- Retirement, resignation or superannuation letter
- Leave encashment calculation statement issued by the employer
- Salary records for the previous 10 months, especially for non-government employees
- Proof of any earlier exemption claimed
According to Surana, the Rs 25 lakh exemption limit for non-government employees is cumulative over a lifetime.
The government raised the tax-free limit for non-government employees from Rs 3 lakh to Rs 25 lakh, effective April 1, 2023.
Employees should preserve these records even after filing their returns. The Income Tax Department may seek clarification if there is a mismatch between the exemption claimed and information available in Form 16, the Annual Information Statement (AIS) or employer disclosures.
TL;DR
Leave encashment received during service is fully taxable. Government employees get full exemption on retirement. Private-sector employees can claim exemption up to Rs 25 lakh, subject to conditions under Section 10(10AA). The benefit remains available under both the old and new tax regimes.
AI summary
- Leave encashment during service is fully taxable.
- Government employees get complete exemption on retirement.
- Private-sector employees can claim exemption up to Rs 25 lakh.
- The exempt amount is the least of four prescribed limits.
- The benefit is available under both old and new tax regimes.
