Leave Encashment: Calculation & Taxation

All salaried have different type of leaves namely: Sick Leave, Casual Leave, Earned/Privilege leave, etc. If employees take lesser leaves than they are eligible for, most employers encash the left over leaves either annually or at the time of leaving the company. Of all types of leaves only earned or privilege leave is encashable.

Leave Encashment Calculation:

There is no fixed rule as how much leaves can be carried forward every year or how many leaves can be encashed. Most employers have their own rules. Usually the basic salary and dearness allowance is taken in consideration for calculation of the amount.

Tax on Leave Encashment:

The tax of leave encashment is dependent on if you are government or private sector employee, or if you are encashing it at the time of retirement or mid-way. We take each case separately.

Also Read: 11 Tax Free Components You Must have in Salary

At the time of Retirement:

Government Employee:

The entire amount received as leave encashment is tax free.

Non Government Employee:

The leave encashment for private sector employees is stated in Section 10 (10AA) and is minimum of the following 4 factors:

  1. Amount received as leave encashment
  2. Maximum cap as stated by government – Rs 3 Lakhs
  3. Last 10 months average basic salary & dearness allowance before leaving the job
  4. Cash equivalent of the leave balance, subject to maximum of 30 days for each completed year of service

We take an example to make the above calculation clear.

Rita is a non-government employee who receives Rs 6 lakh as her leave encashment at the time of retirement. She worked here for 25 years and was eligible for 45 earned leaves every year. Below is the calculation:

  • No. Of earned leaves Rita was eligible for = 45 X 25 = 1,125 days
  • She used 585 leaves over her service period
  • Leaves eligible for leave encashment = 1125 – 585  = 540 days (18 months)
  • Average last 10 months basic + dearness allowance = Rs 25,000

Also Read: 13 Investments to Generate Regular Income

Tax Calculation:

The tax exemption would be minimum of the below 4 points:

  • Amount received as leave encashment – Rs 6 Lakhs
  • Maximum cap as stated by government – Rs 3 Lakhs
  • Last 10 months average basic salary & dearness allowance before leaving the job – Rs 2,50,000 (Rs 25000 X 10)
  • Cash equivalent of the leave balance, subject to maximum of 30 days for each completed year of service – Rs 1,37,500 (as per calculation below)

Earned leave eligibility as per above rule = 30 days X 25 = 750 days

Leaves used = 585 days

Leaves eligible for encashment (as per above rule) = 750 – 585 = 165 days (5.5 months)

Cash equivalent = 5.5 X 25000 = Rs 1,37,500

Tax exemption = Rs 1,37,500

Taxable component = Rs 6,00,000 – Rs 1,37,500 = Rs 4,62,500

Also Read: Making Sense of Tax Benefit on Health Insurance u/s 80D

Post tax deduction the leave encashment would vary from Rs 3.2 lakh (in the 30% tax slab) to Rs 4.15 lakh (in 10% tax slab)

At the time of Resignation:

There are differences between tax experts on the tax treatment of leave encashment at the time of resignation. Some consider it as taxable while others other consider the tax treatment same as at the time of retirement. We support the later:

The leave encashment is tax free for the government employee and the calculation is same as above for non-government employees. However the limit of Rs 3 lakh for non-government employee is for the entire lifetime.  In case you already got Rs 1 lakh while leaving your job, going forward you can only have Rs 2 lakhs as tax exempted leave encashment.

Leave Encashment - Calculation and Taxation

Leave Encashment – Calculation and Taxation

Leave encashment while in Service

If you encash leaves partially or fully while in service the income from encashment is fully taxable for both government and non-government employee.

Leave encashment on Death

The leave encashment is tax free when paid to the nominees or legal heirs at the death of employee.

Also Read: PPF – A Must Have Investment

Important Points:

  • Leave encashment is only for completed years of service. If you have 20 years and 7 months of service, the calculation would be for 20 years only.
  • There is no statutory compulsion to have Leave Encashment Policy. So your employer may or may not have leave encashment at their discretion.
  • Government employees can have maximum of 10 months of leave accumulation and hence encashment

14 thoughts on “Leave Encashment: Calculation & Taxation

  1. An informative article provided. Specified amount of Rs 3,00,000 is the aggregate amount allowed as exemption irrespective of frequency of leave encashment received by employee by various employers. If an employee has utilized Rs 2,00,000 already at the time of first resignation, he is only entitled to use balance of Rs 1,00,000 for the exemption computation next time.

  2. A PSU is a Govt undertaking….owner being Govt. But PSU is not to be confused as Govt. PSU employees are therefore not Govt employees.

  3. manish Dwibedi says:

    Dimag ka dhi karna ho to Leave encasment ke rule padh loo.

  4. Please sir, I have been questioned by an employee, if the family planning incentive is eligible during encashment of leave, what is the rule position. I have no evidence with me. Please inform me whether the family planning incentive eligible. Please give me the govt. Order reference.

    With regards.
    MLNACHARYA

  5. if an employ retireaedon supernuation but his qulifying servivice is 25 years 10 months and 7 days . leaves are 1225 days leave emcashment is due to him or not

  6. Sir/Madam , I am jr assistant in AP BC corporation DEPARTMENT. IAM JOINED 30/08/2016 to till the date ..I have 70 ELs …sir/madam my queastion 1)can I eligible to get surrender leave- encashment in the year2017-2018.& 2) question is I am in prohibition period if it is eligible to get Surrender leave? Plz sir tell me the corresponding G No

  7. SANDEEP JANWALKAR says:

    I AM WORKING IN ONE OF THE NATIONALISED BANK. I AM RETIRING ON 31/07/2018 (NORMAL RETIREMENT AS I AM COMPLETING 60 YRS ON 31/07/2018. MY DATE OF JOINING THE BANK IS 13/05/1977 AND EARNED (PL) LEAVE BALANCE IS 206 DAYS AS ON TODAY. I AVAILED PL 5 DAYS AND FULL PAY SICK LEAVE OF 2 DAYS JUN 2018. THEN PL GUIDE ME HOW TO CALCULATE TOTAL NO. OF DAYS FOR PL ENCASHMENT AND WHAT WILL AMOUNT I WILL GET FOR PL ENCASHMENT. HOW MUCH I TAX WILL BE DEBITED.
    PL GUIDE

  8. can you please elaborate Basic salary, Is it only basic salary or gross salary? please guide

  9. In the example given, 540 days is considered as 18 months(540 days leaves / 30 days per month) . This may not be correct. Suppose if the person would have taken these 540 days of leaves, he would have got more then 18 months as non working days (Saturday, Sunday and general holidays) would not be considered as leaves. So the calculation should be based on the number of working days in a year.
    So excluding Saturday Sunday and general holidays, it would be around 255 working days. So pay per day would be

    annual salary / 255 = Rs. XXX.

    Leave encashment Amount = XXX multiplied by number of days to be encased.

    No?

    • I get your approach but the way mentioned in the post is same as computed on income tax website! For more you can refer here.

  10. V Balakrishnan says:

    Pls advise if PSU is categorised under govt or non-govt for leave encashment

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