Taxation on Leave Encashment
Leave encashment received at the time of retirement is fully exempt from tax under Section 10(10AA)(i) of the Income Tax Act.
- Leave encashment received during the period of service is fully taxable.
- Leave encashment received at the time of retirement, resignation, or termination is partially exempt under Section 10(10AA)(ii). The exemption is subject to the following limits:
- The amount received as leave encashment.
- 10 months' salary (calculated on the basis of the average salary drawn in the last 10 months immediately preceding the date of retirement).
- The maximum limit of ₹25,00,000 (as per the latest amendment).
- The actual leave encashment received at the time of retirement.
Accrual Basis: Under this method, income is taxed when it is earned, regardless of when it is received. This method is more relevant for businesses and professional income.
Cash Basis: Under this method, income is taxed when it is received. This method is typically used for salaried individuals and is more straightforward for tax calculation.
For leave encashment, the taxation generally follows the Cash Basis, meaning it is taxed in the year it is received by the employee.
When leave encashment is received, it is added to your total income for that particular financial year and taxed as per the applicable income tax slabs for that year. The relevant tax slab rates are applied based on the total income, including the leave encashment amount, in the year it is received.
If you are getting the benefit of leave encashment pertaining to previous years, it will still be taxed in the year it is actually received (cash basis). It will be added to your income for the current financial year and taxed according to the tax slabs applicable for the current financial year, not the previous years.
Suppose you received leave encashment in FY 2023-24 for leaves accrued over the previous years. This amount will be included in your income for FY 2023-24, and the applicable tax rates for FY 2023-24 will be applied to this income.
| Category | Income Range | Tax Rate |
|---|---|---|
| Individuals below 60 years | Up to ₹2,50,000 | Nil |
| ₹2,50,001 to ₹5,00,000 | 5% | |
| ₹5,00,001 to ₹10,00,000 | 20% | |
| Above ₹10,00,000 | 30% | |
| Senior citizens (60 to 80 years) | Up to ₹3,00,000 | Nil |
| ₹3,00,001 to ₹5,00,000 | 5% | |
| ₹5,00,001 to ₹10,00,000 | 20% | |
| Above ₹10,00,000 | 30% | |
| Super senior citizens (80 years and above) | Up to ₹5,00,000 | Nil |
| ₹5,00,001 to ₹10,00,000 | 20% | |
| Above ₹10,00,000 | 30% |
These slabs are subject to changes based on the annual budget announcements.
Leave encashment is taxed on a cash basis, meaning it is taxed in the year it is received. The tax rate applied is based on the total income for the year of receipt, according to the current year’s tax slabs. Previous year leave encashment received in the current year will be taxed in the current year itself.
No, leave encashment received at the time of retirement is fully exempt from tax for government employees under Section 10(10AA)(i) of the Income Tax Act.
Leave encashment received during the period of service is fully taxable for non-government employees. However, leave encashment received at the time of retirement, resignation, or termination is partially exempt under Section 10(10AA)(ii), subject to specified limits.
The tax slab rates for individuals below 60 years of age are: Up to ₹2,50,000: Nil, ₹2,50,001 to ₹5,00,000: 5%, ₹5,00,001 to ₹10,00,000: 20%, Above ₹10,00,000: 30%. For senior citizens and super senior citizens, higher exemption limits apply.