Key Takeaways on Leave Encashment Tax Exemption (Section 10(10AA))
- Central and State Government employees get a full exemption on leave encashment received on retirement.
- Other employees (private sector, PSUs, local authorities) get an exemption equal to the lowest of 4 amounts, one of which is Rs 25 lakh (from April 1, 2023). The Rs 25 lakh is an aggregate limit across all employers.
- The other three amounts are: the actual amount received, 10 months' average salary, and the cash equivalent of unavailed leave, counting at most 30 days for each completed year of service.
- TDS is deducted under Section 192 at your slab rate on the taxable part only, not at a flat 10%.
- Report in Schedule S of your ITR, with the exemption shown under Section 10(10AA). The exemption is available under both the old and the new tax regime.
- Leave encashed while still in service is fully taxable as salary (relief under Section 89 may apply for arrears).
When you leave your job (whether by retirement, resignation, or termination), one of the benefits you may receive is leave encashment: payment for unused leave days.
But here's the confusion: How much of this payment is tax-free? How is TDS calculated? Should you report it in your ITR?
This guide covers the complete tax treatment of leave encashment under Section 10(10AA), the exemption limits, TDS deductions, and how to report it correctly for AY 2026-27.
Looking for expert help with leave encashment tax exemption, section 10(10aa), leave encashment limit, leave encashment tds, leave encashment itc reporting, how much leave encashment is tax-free? The team at Tax Garden, based in Kondapur, Hyderabad, helps Indian SMEs stay compliant. End-to-end filings, notices, and deadline tracking, all in one place.
What Is Leave Encashment?
Leave encashment is the payment you receive for the unused leave balance when you exit employment. If you have 30 days of unused leave and your average monthly salary is Rs 30,000, your leave encashment is 30 × Rs 30,000 / 30 = Rs 30,000.
Who Gets Leave Encashment?
Leave encashment is typically paid when:
- You retire from your job on superannuation
- You resign from your job (resignation is treated as retirement for Section 10(10AA))
- You are retrenched or laid off
- Your employment is terminated with notice or ex gratia payment
If an employee dies in service, leave encashment paid to the legal heirs is not taxable in their hands as salary.
Who Doesn't Get Leave Encashment?
- Employees terminated for misconduct or disciplinary reasons (depends on company policy)
- Casual or contractual workers (depends on terms)
- Employees who forfeit leave as per company policy
Leave Encashment Tax Treatment: Key Rules
Leave encashment tax treatment differs sharply between government and other employees:
For Central and State Government Employees
| Aspect | Treatment |
|---|---|
| Exemption | Full exemption (100% tax-free) under Section 10(10AA)(i) |
| Condition | Received on retirement, whether on superannuation or otherwise |
| TDS | Nil on the exempt amount |
| ITR Reporting | Show the receipt and the exemption in Schedule S |
For Other Employees (Private, PSU, Local Authority)
| Aspect | Treatment |
|---|---|
| Exemption | Lowest of 4 amounts under Section 10(10AA)(ii) |
| Overall cap | Rs 25 lakh (CBDT Notification 31/2023, from April 1, 2023), aggregated across all employers |
| TDS | Under Section 192 at slab rates on the part above the exemption |
| ITR Reporting | Declare in Schedule S with the exemption claim |
Leave Encashment Exemption: The Lowest-of-4 Formula
For non-government employees, the exemption is the lowest of these 4 amounts:
| Amount | What it is |
|---|---|
| Amount 1 | Rs 25,00,000 (reduced by any exemption already claimed under Section 10(10AA) from earlier employers) |
| Amount 2 | Actual leave encashment received |
| Amount 3 | 10 × average monthly salary |
| Amount 4 | Cash equivalent of unavailed leave: (leave entitlement at no more than 30 days per completed year of service, minus leave availed or encashed during service) × average monthly salary / 30 |
| Exemption | Lowest of the above 4 amounts |
Average salary means basic pay plus dearness allowance (if it forms part of retirement benefits) plus commission based on a fixed percentage of turnover, averaged over the 10 months immediately preceding retirement or resignation.
Example 1: Fully Exempt
Scenario: Rahul, a private employee, retires after 20 years of service. His average monthly salary for the last 10 months is Rs 80,000. Of his maximum entitlement of 600 days (30 days × 20 years), he availed 450 days, so 150 days are unavailed. The company pays him Rs 4,00,000 (150 × Rs 80,000 / 30).
| Amount | Calculation | Value |
|---|---|---|
| Amount 1 | Statutory limit | Rs 25,00,000 |
| Amount 2 | Actual leave encashment | Rs 4,00,000 |
| Amount 3 | 10 × Rs 80,000 | Rs 8,00,000 |
| Amount 4 | 150 days × Rs 80,000 / 30 | Rs 4,00,000 |
| Exemption (Lowest) | Rs 4,00,000 | |
| Taxable Portion | Rs 4,00,000 − Rs 4,00,000 | Rs 0 |
Example 2: Part of the Payment Is Taxable
Scenario: Rohit, a private employee, resigns after 12 years. His average monthly salary for the last 10 months is Rs 2,00,000. His company's leave policy (40 days a year) lets him encash 400 days, and it pays him Rs 26,66,667 (400 × Rs 2,00,000 / 30). For tax purposes, leave is counted at no more than 30 days per completed year: 360 days, less 60 days he availed, leaves 300 days.
| Amount | Calculation | Value |
|---|---|---|
| Amount 1 | Statutory limit | Rs 25,00,000 |
| Amount 2 | Actual leave encashment | Rs 26,66,667 |
| Amount 3 | 10 × Rs 2,00,000 | Rs 20,00,000 |
| Amount 4 | 300 days × Rs 2,00,000 / 30 | Rs 20,00,000 |
| Exemption (Lowest) | Rs 20,00,000 | |
| Taxable Portion | Rs 26,66,667 − Rs 20,00,000 | Rs 6,66,667 |
The taxable Rs 6,66,667 is added to Rohit's salary for the year and taxed at his slab rate.
TDS Deduction on Leave Encashment
The employer deducts TDS on leave encashment under Section 192, treating the taxable part as salary. There is no flat 10% rate.
How TDS Works
- The employer works out the Section 10(10AA) exemption.
- The taxable balance is added to your estimated salary income for the year.
- TDS is computed at your slab rates under the regime you have chosen with the employer, after the standard deduction.
Example
If Rohit (Example 2) has other salary of Rs 18,00,000 in the year of exit under the new regime, his taxable salary becomes Rs 18,00,000 + Rs 6,66,667 − Rs 75,000 = Rs 23,91,667. The extra Rs 6,66,667 falls partly in the 20% slab and mostly in the 25% slab, so TDS on it will be well above 10%.
What If the Exemption Covers the Full Amount?
If the exemption is equal to or more than the leave encashment, no TDS arises on it.
How to Report Leave Encashment in ITR
Leave encashment must be reported in Schedule S of your ITR (Income Tax Return) under the head "Salaries":
Steps to Report in ITR
- Open your ITR-1 or ITR-2 on the e-Filing portal
- Go to Schedule S - Salary Income
- Include the gross leave encashment in salary as shown in Form 16
- Select the exempt allowance Section 10(10AA) and enter the exempt amount
- The taxable balance flows into your salary income
- TDS deducted by the employer appears in Schedule TDS1 from Form 16 / Form 26AS
Claiming TDS Credit
If TDS was deducted on leave encashment, it is part of the salary TDS reported by your employer. Check it against Form 26AS; if your final tax is lower than the TDS, the excess is refunded.
Common Scenarios and Tax Treatment
| Scenario | Leave Encashment | Exempt | Taxable |
|---|---|---|---|
| State Government employee on retirement | Rs 12,00,000 | Rs 12,00,000 | Rs 0 |
| Private employee, Example 1 | Rs 4,00,000 | Rs 4,00,000 | Rs 0 |
| Private employee, Example 2 | Rs 26,66,667 | Rs 20,00,000 | Rs 6,66,667 |
| Leave encashed during service (any employee) | Any amount | Nil | Full amount |
Aggregate Rs 25 Lakh Limit Across Employers
The Rs 25 lakh ceiling under Section 10(10AA)(ii) is aggregated across all employers: exemption already allowed on leave encashment from earlier employers reduces the limit available later.
Example: Multiple Exits
- First exit (resignation at age 35): leave encashment Rs 8 lakh, exemption claimed Rs 8 lakh
- Second exit (age 50): leave encashment Rs 12 lakh; remaining limit Rs 25 lakh − Rs 8 lakh = Rs 17 lakh; exemption claimed Rs 12 lakh (assuming the other three amounts are higher)
- Remaining limit = Rs 25 lakh − Rs 8 lakh − Rs 12 lakh = Rs 5 lakh
If a third leave encashment of Rs 6 lakh is received later, at most Rs 5 lakh can be exempt, and Rs 1 lakh will be taxable.
Employer Obligations
Employers must:
- Calculate the exemption under Section 10(10AA) before deducting TDS
- Deduct TDS under Section 192 on the taxable portion at slab rates
- Issue Form 16 showing the leave encashment, the exemption and the TDS
- File the quarterly TDS return (Form 24Q for FY 2025-26)
Common Mistakes to Avoid
1. Not claiming the exemption
Many employees pay tax on leave encashment without realizing the Section 10(10AA) exemption. Check that Form 16 shows it, and claim it in your ITR if it does not.
2. Miscalculating the "lowest-of-4"
Use average salary of the 10 months before exit, and cap leave at 30 days per completed year of service for Amount 4, even if your company allows more.
3. Using the old Rs 3 lakh limit
The limit for non-government employees was Rs 3 lakh until March 31, 2023. It is Rs 25 lakh for exits on or after April 1, 2023.
4. Not reporting TDS deducted
If TDS was deducted, ensure it matches Form 26AS and is claimed in the return.
5. Forgetting the aggregate cap
If you have received exempt leave encashment before, the Rs 25 lakh limit is reduced by what you already claimed.
6. Treating government and private employee benefits the same
Only Central and State Government employees get full exemption; PSU and private employees get the "lowest-of-4" exemption.
Key Takeaways
-
Central and State Government employees: Full exemption on leave encashment received on retirement.
-
Other employees: Exemption = lowest of Rs 25 lakh, actual amount, 10 months' average salary, and cash equivalent of unavailed leave (max 30 days per year of service).
-
TDS under Section 192 at slab rates on the taxable part only.
-
Report in Schedule S of your ITR with the exemption under Section 10(10AA); it applies in both tax regimes.
-
Rs 25 lakh cap is aggregated across all employers.
-
Retirement includes resignation, retrenchment and termination, not leave encashed while in service.
Where Tax Garden Helps
Leave encashment reporting and ITR filing can be complex, especially when you're juggling multiple jobs, retirements, or non-traditional exits.
Tax Garden's tax experts help you:
- Calculate the correct "lowest-of-4" exemption under Section 10(10AA)
- Correctly calculate and claim your tax-free leave encashment benefit
- Ensure TDS is correctly deducted and credited
- Report leave encashment correctly in your ITR
- Recover TDS overpayment as a refund
Looking for expert help with leave encashment tax exemption, section 10(10aa), leave encashment limit, leave encashment tds, leave encashment itc reporting, how much leave encashment is tax-free? The team at Tax Garden, based in Kondapur, Hyderabad, helps Indian SMEs stay compliant. End-to-end filings, notices, and deadline tracking, all in one place.
Leave Encashment Tax Exemption: Frequently Asked Questions
How much leave encashment is tax-free?
Central and state government employees get a full exemption on leave encashment received at retirement. For other employees, Section 10(10AA)(ii) exempts the lowest of four amounts: Rs 25 lakh, the actual amount received, 10 months' average salary, and the cash equivalent of unavailed leave counted at no more than 30 days for each completed year of service. Anything above the exemption is taxed as salary.
Is TDS deducted on leave encashment?
Yes, on the taxable portion only. The employer adds the amount above the Section 10(10AA) exemption to your salary for the year and deducts TDS under Section 192 at your applicable slab rate, not at a flat 10%. If the whole payment falls within the exemption, no TDS arises on it. The exemption and the tax deducted should both appear in your Form 16 for the year of exit.
How is the cash equivalent of unavailed leave worked out?
Take your leave entitlement at no more than 30 days for each completed year of service, subtract the leave you availed or encashed while in service, and multiply the balance by your average monthly salary divided by 30. Average salary here means basic pay plus dearness allowance that counts for retirement benefits and any turnover-based commission, averaged over the 10 months before retirement or resignation.
How do I report leave encashment in my ITR?
Report leave encashment in Schedule S of your ITR under 'Salaries.' Enter the gross leave encashment, the exemption claimed under Section 10(10AA), and the taxable balance. If TDS was deducted, claim the credit in Schedule TDS.
Is leave encashment for government employees always fully exempted?
Central and State Government employees get a full exemption under Section 10(10AA)(i) on leave encashment received on retirement. Employees of PSUs, local authorities and other government-owned bodies are treated as non-government employees and get the lowest-of-4 exemption with the Rs 25 lakh cap.
What if my leave encashment exceeds Rs 25 lakh?
The total exemption is capped at Rs 25 lakh lifetime across all employments. The excess amount is taxable. For example, if you receive Rs 30 lakh over two exits and the other limits are higher, only Rs 25 lakh is exempt and Rs 5 lakh is taxable.
Can leave encashment received during employment be exempted?
'Leave encashment' is typically only exempted under Section 10(10AA) when received on exit (retirement, resignation, retrenchment, termination). Leave paid during employment is fully taxable as salary.
Sources: Income Tax Act, 1961, Section 10(10AA); CBDT Notification No. 31/2023 (Rs 25 lakh limit); Income Tax Department e-Filing portal; Economic Times; The Hindu Business Line; Financial Express; Right to Information Wiki. Verify current rules on incometax.gov.in before acting, as rules may be updated periodically. This article is general information on leave encashment tax treatment and not a substitute for professional tax advice.
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