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.
How to Pay 0 Income Tax on Salary of Rs 20+ Lakh (FY 2020-21)?
As you can see with the above income tax calculation, salary components and salary structure plays a very important role in how much income tax you pay. We have come up with some optimised salary structure using which you pay NO income tax even with CTC of more than Rs 20 Lakhs.
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:
- Amount received as leave encashment
- Maximum cap as stated by government – Rs 3 Lakhs
- Last 10 months average basic salary & dearness allowance before leaving the job
- 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
How much Taxes you Need to Pay this Year? Download Our Income Tax Calculator to Know your Numbers
Do you know how much tax you need to pay for the year? Have you taken benefit of all tax saving rules and investments? Should you use the “NEW” tax regime or continue with the old one? In case you have all these questions just Download the Free Excel Income Tax Calculator for FY 2021-22 (AY 2022-23) and get your answers.
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
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)
Best Investment to Save Tax
Section 80C offers more than 10 investments where you can invest to save tax, However many a times you need not actually do this investment as its already covered due to expenses like children tuition fee or automatic EPF deduction for salaried. In case you are new to taxes and investment do read our helpful guide on How to take maximum advantage of Section 80C and choose the best investment to save tax.
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 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.
Should you Invest in Gold?
We looked at more than 55 years history of gold to see if its a good idea to invest in Gold. We concluded that its more volatile than perceived but investing in long term may provide you with more stable returns. You can look at the complete analysis and our conclusion here – Looking at Gold Price History in India – Should you Invest in Gold?
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