Leave Encashment- Taxation and Exemptions

As a salaried employee, you are entitled to various types of leave, such as sick leave, casual leave, annual or earned leave, and so on. Several companies allow employees to carry forward their accumulated leaves, which can be encashed at the time of retirement or resignation. The amount received through this facility is subject to the Leave Encashment Tax and is not exempt. Let's take a look at how leave encashment is taxed.

What is leave encashment?

Leave encashment means that if a specific employee of an organisation still has paid leaves remaining, they can encash those leaves. Leave encashments are completed during a specific time period. If you are a government employee, your leave encashment is tax-free, but if you are not, certain taxations may apply to your leave encashment. There is a calculation of leaves as well as the amount is calculated based on certain parameters, basic pay and the dearness allowance, for such encashment to occur.

Leave Encashment Taxation

Leave encashment during service-

Accumulated leave can be redeemed either during service or upon retirement or resignation. Any leave taken during service is fully taxable and is included in 'income from Salary.' Section 89 relief, on the other hand, can be sought (refer this circular).

Encashed leave at the time of retirement or resignation

• Leave encashment received at the time of retirement or resignation is either fully or partially exempt depending on the employee's classification. This has been expanded upon further below:
• A Central or State Government employee's leave encashment at the time of retirement or resignation is fully exempt.
• Legal heirs of deceased employees who receive leave encashment are fully exempt.
• Non-government employees' leave encashment is exempt based on the computation provided in Section 10(10AA)(ii), and any balance amount is taxable as 'income from salary.'

Exemptions-

• The last ten months' average monthly pay
• The government allows a maximum of 3 lakh
• For each year of service, the cash equivalent of paid leaves (up to 30 days).
• If received by an employee in service, proceeds collected for leave encashment are chargeable.
• The amount of leave encashment received at retirement is tax-free.
• Under income tax rules, the value of leave encashment is treated as payroll income and taxed at the employee's specific tax slab rate.

Tax planning can be done based on an individual's income and the employer's leave encashment policy by deciding whether it is better to encash leave year after year or to receive a lump sum at the time of retirement or resignation.