Leave Encashment is the financial compensation paid by an employer to an employee for accumulated unavailed earned leaves. Under the Income Tax Act, 1961, Section 10(10AA) governs the tax treatment of leave encashment received during service or upon retirement/resignation.
Key Highlight for FY 2026-27:
The statutory lifetime tax exemption limit for non-government employees under Section 10(10AA) stands elevated at ₹25,00,000 (₹25 Lakhs). This exemption applies under both the Old and New Tax Regimes.
1. Tax Treatment: Government vs Non-Government Employees
The Income Tax Act classifies employees into two distinct categories for Section 10(10AA) tax exemption benefits:
| Employee Category | Received During Service | Received Upon Retirement / Resignation |
|---|---|---|
| Central / State Govt Employees | Fully Taxable | 100% Exempt (No Limit) |
| Non-Government / Private Employees | Fully Taxable | Exempt up to Least of 4 Limits (Max ₹25L) |
2. Calculation Formula for Private Employees
For non-government private sector employees, the tax-exempt amount under Section 10(10AA) is the LEAST of the following four amounts:
- Actual Leave Encashment Amount Received from the employer.
- Statutory Monetary Ceiling: ₹25,00,000 (₹25 Lakhs).
- 10 Months' Average Basic Salary (Average basic salary + DA of 10 months preceding retirement).
- Cash Equivalent of Earned Leaves based on maximum 30 days leave per year of completed service.
3. Earned Leave Balance Calculation Example
Suppose an employee worked for 20 years with an average 10-month basic salary of ₹80,000/month. The company allowed 30 days earned leave per year, and the employee accumulated 200 days of unavailed leave, receiving ₹5,33,333 as encashment:
- Limit 1 (Actual Received): ₹5,33,333
- Limit 2 (Statutory Ceiling): ₹25,00,000
- Limit 3 (10 Months Basic Salary): 10 x ₹80,000 = ₹8,00,000
- Limit 4 (Cash Equivalent): (200 / 30) x ₹80,000 = ₹5,33,333
Since the least of the four limits is ₹5,33,333, the entire leave encashment amount is 100% Tax-Exempt!
Frequently Asked Questions (FAQs)
Q1: What is the maximum tax exemption limit for leave encashment under Section 10(10AA)?
For non-government employees, the maximum lifetime tax exemption limit for leave encashment received at retirement or resignation is ₹25,00,000 (₹25 Lakhs) under Section 10(10AA).
Q2: Is leave encashment during service taxable?
Yes. Leave encashment received by an employee while continuing in employment (during active service) is fully taxable for both government and private employees.
Q3: Are central government employees fully exempt from tax on leave encashment?
Yes. Any leave encashment amount received by Central or State Government employees at the time of retirement or superannuation is 100% exempt from income tax without any monetary limit.
Q4: How is 10 months average basic salary calculated for leave encashment exemption?
The 10 months average basic salary is computed by taking the average of basic salary and dearness allowance (DA) drawn during the 10 months immediately preceding the date of retirement or resignation.
Q5: Does the ₹25 Lakh leave encashment exemption limit apply under the New Tax Regime?
Yes. The statutory leave encashment tax exemption under Section 10(10AA) is available under both the Old Tax Regime and the New Tax Regime under Section 115BAC.