Leave Encashment Tax

The following conditions apply when considering tax on leave encashment:

1. If you encash your leave while you are still working in the company/government office, then that amount is subject to tax without any exemption.
2. Government employees - whether they are with the Central Government or the State Government - are not liable to pay any tax on leave encashment income at the time of superannuation or resignation.
3. The income received by private sector employees as leave encashment after retirement or resignation is taxable as 'Income from Salary'. But certain exemptions are applicable to this income. After allowing for the exemption, the remaining amount will be added to the regular income and taxed as per the income tax slabs.
4. Private sector employees can get exemption on leave encashment income under Section 10(10AA).

Exemption under Section 10(10AA)

A part of the leave encashment income at the time of superannuation or resignation is exempt from income tax payment. This exemption is applicable to the lowest of the below amounts:

1. Rs. 3 lakh
2. Actual leave encashment amount
3. Average salary (basic salary + dearness allowance) of the last 10 months before the employee's retirement or resignation
4. Cash equivalent of pending leave days. The leave basis is a maximum of 30 days leave for every year of service.

For Example:

 Rajani Mathur resigned her job in a private company after 18 years of service. She had a leave allowance of 40 days per year, adding up to 720 days of leave during the whole of her service. Out of this, she had taken 500 days of leave, leaving her with 220 (7.3 months) to encash. She receives Rs. 2.64 lakh on encashment. Her basic salary plus DA was Rs. 36,000 per month for the last 1 year of her service. As for pending leave days for tax calculation, instead of 40, it would be considered that she received earned leave of 30 days per month. So the pending leave days would be 40 days (30 days x 18 years = 540 days — 500 leave days availed) instead of 220 days.

To know how much of this amount is exempted from taxation, let us calculate all 4 of the above numbers.

1. Rs. 3 lakh
2. Actual leave encashment amount: Rs. 2,64,000
3. Average salary of the last 10 months: Rs. 3,60,000
4. Cash equivalent of pending leave days: Rs. 48,000 (40 x per day average salary of Rs. 1,200)

The lowest of the above amounts is Rs. 48,000. Rajani Mathur will get exemption for that amount out of the Rs. 2.64 lakh that she received as leave encashment. The remaining amount - Rs. 2.16 lakh - will be subject to income tax as per her slab, i.e. between 10% to 30%.

Types of Leaves

1. Medical Leave: Medical leaves are of utmost importance as they cater to health-related issues. The availability and limits of medical leave vary from one organization to another. Employees are typically required to provide medical certificates to justify their absence. Some companies may offer paid medical leave, while others might have a combination of paid and unpaid medical leave.
2. Earned Leave or Privilege Leave: These are leaves that employees accrue over time based on their tenure with the company. They can be availed after providing prior notice to the employer. The key feature is that earned leaves are eligible for encashment, meaning employees can choose to receive payment for the unused leaves at the end of the year or when leaving the organization. The specific period for eligibility varies depending on the organization's policy.
3. Casual leaves: Casual leaves are usually granted for personal reasons, such as attending to personal matters or emergencies. They typically range from 7 to 10 days annually and are not eligible for encashment in most cases. The encashment policy for casual leave varies across companies, but it is generally not encouraged due to their casual nature.
4. Holiday Leave: These leaves are granted by employers without any deduction from the employee's salary. The maximum number of holiday leaves permitted may differ from company to company. They are often given on specific holidays, such as national or public holidays, and are meant for employees to enjoy time off on these occasions.
5. Maternity Leave: Maternity leaves are exclusively available for female employees during pregnancy and childbirth. The duration of maternity leave can vary from 12 to 26 weeks, depending on the country's labor laws and the organization's policies. While employees can request extensions, no payment is made for that additional period, and these leaves are not eligible for encashment.

1. Paternity Leave: This type of leave is specifically designated for male employees who become fathers. However, in India, it's exclusively accessible to government employees. Eligible parents can take up to 15 days off before or after their child's birth, or within six months from the child's birth. Notably, paternity leave cannot be converted into leave encashment.
2. Sabbaticals: Sabbaticals are leaves granted to employees to enhance their skills and knowledge. During this period, employers may reimburse the leaves if employees enroll in a course or pursue upskilling opportunities. Sabbaticals are often considered a valuable benefit as they support employees in their professional development and contribute to their long-term career growth.
3. Half-pay Leave: This particular leave benefit is solely accessible to government employees. After completing one year of service, they have the option to take half-pay leaves as needed. During this leave, employees receive half of their regular daily salary. The possibility of including these leaves in leave encashment depends on the policies of the respective government organization.
4. Quarantine Leave: Employees are eligible for this type of leave when there is a case of infectious disease either in their family or neighborhood. Providing quarantine leave helps mitigate the risk of disease transmission among colleagues. It's important to note that this leave cannot be converted into leave encashment 

Here is a table summarizing the types of leave and whether leave encashment is available:

Please note that the availability of leave encashment may vary depending on the specific policies of the organization or government entity. 

Leave Encashment Procedure

Leave encashment is a benefit that most employees can access if they have accrued unused leave days, and their employer permits this practice. It offers flexibility and additional financial support to employees.

Leave Encashment is processed in the following steps:

1. Step 1: Throughout the year, if an employee doesn't use all of their entitled vacation or leave days, they can save these unused days. At a later time, the employee can formally ask their employer for leave encashment. This means they want to exchange their saved leave days for extra money.

1. Step 2: The employer reviews the request and decides whether to approve it. They may have specific policies and rules regarding leave encashment.
2. Step 3: If approved, the employer calculates how much money the employee will receive for their unused leave days. This calculation is typically based on the employee's salary and the number of days of leave.
3. Step 4: The employer then pays the employee the agreed-upon amount, either as part of their regular salary or as a separate payment.

What is the maximum limit of leave encashment?

The government has set the upper limit at Rs.25 lakh which is calculated based on the last 10 months of basic salary and DA, multiplied by the daily salary rate, and then multiplied by the unutilized leave days (with a maximum of 30 days per year) for each completed year of service.

It can be calculated by using the following formula:

Maximum Leave Encashment Amount = [Last 10 Months of Basic Salary + Dearness Allowance] × [Salary per Day] × [Unutilized Leave Days (up to a maximum of 30 days per year)] × [Number of Completed Years of Service]

Other Important Points

If you encash your leave days more than once during your work history, the maximum exemption of Rs. 3 lakh is applicable to the total amount you earn as leave encashment income from all jobs. So if you have already claimed exemption on Rs. 1 lakh after resigning from one job, then in the next jobs you will have a maximum of Rs. 2 lakh available as exemption.

If your leave encashment is received by one of your legal heirs after your death, then that amount, however high, is not subject to taxation.

Each company has a different leave encashment policy. Some may allow you to continue your leave balance without any limit, while some put a cap on the number of years you can carry forward the remaining leave days for. If your company allows you to carry forward a large number of leave days, make sure you estimate the tax you'll have to pay at the time of encashment. It might be beneficial not to wait too long to encash your leave in order to avoid getting a lump sum amount in hand. If the company has less than 30 days of leave per year, then the exempted amount will not be lower than the actual leave encashment amount, which will give you a higher exemption.