Encashment of Earned Leave on Retirement
When an employee retires, they may receive money for the earned leave that was not used during their service. This is called Leave Encashment. It is considered as income, but the Income Tax Act provides exemptions under certain conditions.
Leave Encashment under Section 10(10AA)
There are two categories for tax treatment:
- Government Employees: Leave encashment is fully exempt from tax.
- Non-Government Employees: Leave encashment is exempt up to a certain limit.
Maximum Limit for Exemption (Non-Government Employees)
Leave encashment is exempt up to the least of the following four:
- ₹3,00,000 (lifetime exemption limit)
- Actual leave encashment received
- 10 months’ average salary
- Cash equivalent of leave at credit (max. 30 days leave per year of service)
Note:
- Average salary = Basic + Dearness Allowance (if part of retirement benefits) + Commission (if based on % of turnover), for last 10 months.
- Any earlier exemption claimed reduces the ₹3 lakh limit.
Example:
If a non-government employee receives ₹4,00,000 as leave encashment and the least of the above four amounts is ₹2,80,000, then:
- Exempt = ₹2,80,000
- Taxable = ₹1,20,000
Conclusion
Encashment of earned leave provides financial support post-retirement. Government employees enjoy full exemption, while non-government employees can claim partial exemption as per Section 10(10AA).