Leave Encashment Tax on Resignation for Private Employees: Section 10(10AA), the Rs. 25 Lakh Lifetime Cap and the New Regime

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Resignation is where leave encashment tax is most often computed wrongly, and it is wrong in a specific direction. Employees assume the Rs. 25 lakh figure they have read about is what they can claim. It almost never is. For a private sector employee resigning mid-career, the binding constraint is nearly always the fourth factor, the cash equivalent of leave to your credit, which typically lands somewhere between Rs. 3 lakh and Rs. 8 lakh. The Rs. 25 lakh ceiling is a backstop that most people never reach.

This guide works through the four-factor test as it applies on resignation, the lifetime cap across employers, why the new tax regime leaves the benefit intact, and the two places where the arithmetic usually goes wrong.

When Leave Encashment Is Taxable and When It Is Not

The trigger is the timing of the payment, not the reason you accumulated the leave.

Resignation and retirement are treated identically. The statute says "retirement whether on superannuation or otherwise", and voluntary resignation falls inside "or otherwise". Nothing turns on whether you left by choice.

The in-service point matters more than it looks. Some employers run an annual encashment window where staff can convert surplus leave to cash each year. Every rupee taken through that window is fully taxable when paid, and it also reduces the balance available at exit, so it shrinks the exempt amount you can eventually claim. Employees who encash annually and then resign often find their exemption is a fraction of what they expected.

Government Versus Private: Why the Split Exists

"Government employee" means an employee of the Central Government or a State Government. It does not extend to employees of public sector undertakings, nationalised banks, statutory corporations, universities, or local authorities, all of whom are taxed under clause (ii) with the ceiling. This catches bank and PSU staff repeatedly, because the employer feels governmental in every other respect.

The Four-Factor Test for Private Employees

The exempt amount is the lowest of these four.

Step-by-Step Guide

Computing the exemption on resignation

Four figures, then take the smallest

1

Read the actual figure off the settlement

Take the leave encashment line from your full and final settlement, before TDS. This is factor one and it is the only figure you do not have to compute.

Factor 1

2

Reduce the ceiling by past claims

Start at Rs. 25 lakh and subtract every Section 10(10AA) exemption you have claimed at earlier employers across your working life. The remainder is factor two, not the full Rs. 25 lakh.

Factor 2

3

Average the last ten months of salary

Add basic pay, dearness allowance forming part of retirement benefits, and turnover-based commission for the ten months immediately before you leave. Divide by ten for the monthly average, then multiply by ten for factor three.

Factor 3

4

Recompute leave credit under the 30-day cap

Take the lower of your actual unused leave balance and (30 days times completed years of service, minus leave already availed or encashed). Value it at average monthly salary divided by 30. That is factor four.

Factor 4

5

Take the smallest and subtract

The lowest of the four is exempt. The excess of the actual amount over it is taxable salary at your slab rate and your employer should have deducted TDS on exactly that excess under Section 192.

Result

Source: Section 10(10AA)(ii), Income Tax Act 1961; CBDT Notification No. 31/2023 dated 24 May 2023

What counts as salary here

This definition is the reason the exemption disappoints. A private salary of Rs. 2 lakh a month is often structured as Rs. 80,000 basic and the rest in allowances. Factors three and four are both computed on the Rs. 80,000, not the Rs. 2 lakh, so both collapse to roughly 40% of what an employee reading the gross figure would expect.

Worked Example: Twenty Years, Resignation

An employee resigns after 20 completed years. Average monthly basic plus qualifying dearness allowance over the last ten months is Rs. 1,00,000. The employer credited 15 days of earned leave a year, so entitlement over the period was 300 days, of which 100 were taken. The settlement pays Rs. 12,00,000 for the 200-day balance. No exemption was claimed at any earlier job.

The lowest is Rs. 6,66,667, so that is exempt. The taxable portion is Rs. 12,00,000 minus Rs. 6,66,667, which is Rs. 5,33,333, added to total income and taxed at slab rates.

Note what did not bind. The Rs. 25 lakh ceiling was never close to relevant, and the 30-day cap did not bite because the employer's policy of 15 days a year was already well inside it.

When the 30-day cap does bite

Change one fact. Suppose the employer credited 45 days a year. Over 20 years the entitlement is 900 days, 100 were taken, and the balance is 800 days, all of which the employer pays for.

For the exemption, leave credit is recomputed as 30 times 20 completed years, which is 600 days, less the 100 days already availed, leaving 500 days. Factor four becomes 500 times Rs. 3,333, which is Rs. 16,66,667. Factor three, ten months of salary at Rs. 10,00,000, is now the lowest and governs instead.

The employee is paid for 800 days but the exemption is computed as if the cap and the salary test applied, which they do. A generous leave policy increases the cash you receive and increases the taxable share of it.

The Rs. 25 Lakh Ceiling Across Employers

The Central Board of Direct Taxes raised the ceiling from Rs. 3 lakh to Rs. 25 lakh through Notification No. 31/2023 dated 24 May 2023, effective 1 April 2023 and therefore applying from assessment year 2024-25. The Rs. 3 lakh figure had been unchanged since 2002.

The ceiling is a single lifetime aggregate. It does not reset when you change jobs.

Take an employee who claimed Rs. 10 lakh of exemption on leaving Company A, then resigns from Company B with a settlement of Rs. 12,00,000, ten months of salary at Rs. 14,00,000, and leave credit worth Rs. 13,00,000.

The exempt figure is Rs. 12,00,000, the lowest of the four. Note the reasoning carefully: it is exempt because the actual amount is the smallest, not because Rs. 12 lakh fits inside the Rs. 15 lakh headroom. Headroom is a ceiling on the claim, never a licence to claim up to it. Had the settlement been Rs. 16,00,000, the exempt figure would have been Rs. 13,00,000 on factor four, not the Rs. 15,00,000 of remaining headroom.

Two practical consequences follow. Track your cumulative claims across your whole career, because nobody else does it for you. And tell your new employer what you have already claimed, because they compute TDS on the assumption that they know your position. Silence here produces under-deducted TDS, which you settle later as self-assessment tax with interest under Sections 234B and 234C.

Old Regime Versus New Regime

The exemption is available under both regimes. Section 115BAC removes most Chapter VI-A deductions and a long list of allowances, but Section 10(10AA) is not among the casualties. Nor are gratuity under Section 10(10) or commuted pension under Section 10(10A). Exit benefits were deliberately left intact when the regime was designed.

What changes between regimes is everything around it. In the old regime the taxable balance sits on top of an income already reduced by Section 80C, 80D, and housing interest, so the marginal rate applied to it may be lower. In the new regime the taxable balance faces the new slabs with only the standard deduction against salary. Which regime wins in a resignation year depends on your total position, and a large taxable leave encashment can flip an answer that was settled in a normal year. The comparison is worked through in old versus new tax regime for AY 2026-27 and the applicable bands are in income tax slab rates for FY 2025-26.

TDS, Form 16 and Reporting

Your employer deducts TDS under Section 192 on the taxable portion only, and reports the exempt amount separately in the TDS certificate. Three checks are worth making before you file.

Check the exempt figure on the certificate. Payroll teams sometimes apply the full Rs. 25 lakh as factor two without asking about earlier claims, which overstates the exemption and under-deducts tax. The shortfall is yours to pay with interest, not theirs.

Check that a mid-year resignation was handled. If you joined a new employer in the same year, the new employer needs your previous salary details to deduct correctly, which is the mechanism covered in Section 192(2) and TDS on a job change.

Reconcile against Form 26AS. Confirm the credit actually appears before filing. The comparison method is set out in AIS versus Form 26AS versus TIS.

The certificate itself is being renumbered under the Income Tax Act 2025, covered in Form 130 replacing Form 16. The provision numbering also changes under the new Act, and the correspondence between old and new sections is mapped in the Income Tax Act 2025 section mapping.

Keep the settlement letter, the last ten months of payslips, the leave ledger showing the balance and everything availed, the resignation acceptance, and records of any exemption claimed at earlier employers. The last of these is the one nobody retains and the one an assessing officer asks for.

Where This Sits Among Your Exit Payments

Leave encashment is one of several payments on exit and each has its own rule. Gratuity carries a separate Rs. 20 lakh exemption under Section 10(10), covered in gratuity calculation and tax exemption. Notice pay recovered from you is a deduction from salary, not a loss you can set off. Provident fund withdrawal has its own conditions and its own TDS section.

For the general rules that apply on retirement rather than mid-career resignation, see leave encashment tax exemption under Section 10(10AA) and the shorter leave encashment tax rules.

Key Points to Remember

1. Encashment during service is fully taxable. Only the exit triggers Section 10(10AA), and annual encashment windows shrink what you can eventually exempt.
2. For private employees the exempt amount is the lowest of four figures, and in most mid-career resignations the binding figure is leave credit or ten months of salary, not the Rs. 25 lakh ceiling.
3. The ceiling is a lifetime aggregate across all employers. It reduces with every claim and never resets.
4. Remaining headroom is a ceiling, not an entitlement. You still take the lowest of four.
5. Salary here means basic, qualifying dearness allowance, and turnover-based commission only, which is why the exemption is far smaller than gross CTC suggests.
6. The exemption survives the new tax regime untouched, but the regime choice in a resignation year should be recomputed with the taxable balance included.

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Statutory references: Sections 10(10AA), 15, 17(1)(va), 115BAC, 192, 234B and 234C of the Income Tax Act, 1961; CBDT Notification No. 31/2023 dated 24 May 2023; CBDT Circular No. 309 dated 3 July 1981. Verify current limits and procedures on incometaxindia.gov.in before acting. This article is general information and not a substitute for professional advice.