What is Leave Encashment?
Leave encashment refers to the money an employee receives in return for unused paid leaves during the year. According to labor laws, salaried employees are entitled to a certain number of paid vacation days, which are determined by the employer. Additionally, many companies allow employees to carry forward unused paid leaves to the following year. Consequently, an unutilized leave balance may accumulate in an employee’s leave quota by the time of departure or retirement. Upon off-boarding, the company must reimburse the employee for any unutilized paid leave, and this payment is referred to as leave encashment.
Benefits Of Leave Encashment
- If an employee is in service, the proceeds obtained from leave encashment are charged. If you leave a job due to dismissal or resignation, you must pay the entire sum collected, whether you work in the private or public sector. Income tax laws treat the amount earned from this process as payroll income, and it is taxed according to the applicable slab.
Leave encashment rule
The leave encashment rule for non-government employees is exempt up to a certain limit. Initially, this limit was set at 3 lakhs in 2002 due to the relatively low salaries of employees at the time. However, the limit was recently revised to 25 lakhs due to a substantial increase in employee salaries.
Any payment received as leave encashment at the time of retirement, up to 25 lakhs, is exempt from income tax. However, any amount beyond this is taxable under the salary head of income tax.
Various Types
The different types of leaves vary from organization to organization. Here are some common types of leaves provided by organizations
1. Casual leave
Casual leaves are available for a short time that usually varies from 7 to 10 days. Employees may avail of these leaves for personal reasons. Encashment of casual leaves vary from organization to organization.
2. Earned leave or privilege
An employee can avail of earned leaves with prior notice to the designated authority. These leaves become eligible for encashment after a certain period. This policy varies from organization to organization.
3. Medical leaves
Employees generally take medical leave when they are unable to perform their duties due to poor health. The encashment of medical leaves, however, may vary depending on the organization’s policy.
4. Holiday leaves
Holidays may be granted to employees and no salary would be deducted for that. The number of holidays provided may vary from organization to organization.
5. Maternity leaves
Employers provide maternity leaves to pregnant female employees ranging from 12 to 26 weeks. Additionally, an employee can request an extension, but no salary will be provided during that period. However, these leaves are not available for further extension beyond this.
6. Sabbaticals
Employees can take leaves to upskill and expand their knowledge base. During this time, they can enroll in courses to learn new skills, and in some cases, employers may reimburse these leaves.
Taxation on leave encashment
Here are the taxation rules on leave encashment in various situations:
1. Leave encashment received during service
The tax on leave encashment depends on when it is received. If an employee receives leave encashment during their tenure, it is fully taxable under the salary head of income tax. However, some tax benefits can be claimed under Section 89 of the Income Tax Act. To claim this deduction, you can fill out a specific form designed for this purpose.
2. Encash the leaves at the time of termination
Here are the conditions under which an employee can claim a tax deduction on leave encashment at the time of termination.
Firstly, the extent of the tax deduction usually depends on the sector in which you are working. For instance, state and central government employees enjoy full tax exemption on encashment of leave. On the other hand, non-government employees receive a partly exempt and partly taxable benefit. This exemption is based on Section 10 of the Income Tax Act.
Moreover, in the unfortunate event of an employee’s death, the legal heir who receives the leave encashment amount is fully exempted from income tax.
Calculation
The formula for calculating leave encashment exemption of a non-government employee
“Proposed limit of income tax exemption for a non-government employee has been increased from 3 lakh to 25 lakh.
Particulars                                                                                           Amount
Â
1. Leave encashment received (A)                                                                …………..
2. (-) Exemption under Section (10AA)- (B) Least                                               …………..
Of the following
Â
(i) Amount notified by the government (2500000) ©
(ii) Actual leave encashment amount (D)Â
(iii) Average salary of last 10 months (E)
(iv) Salary per day* unutilized leave (considering
Maximum 30 days in a year for completed service)
Leave encashment taxable (A)-(B)                                                                …………..
Let’s understand how it is made using a simple illustration.
FAQs (Frequently Asked Questions)
Leave encashment refers to the money that an employee receives for their unutilized leaves in an organization.
You can either encash or clear your leaves at the time of termination or layoff.
The other terms used for leave encashment are holiday pay and vacation days.