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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.
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.
The different types of leaves vary from organization to organization. Here are some common types of leaves provided by organizations
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.
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.
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.
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.
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.
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.
Here are the taxation rules on leave encashment in various situations:
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.
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.
“Proposed limit of income tax exemption for a non-government employee has been increased from 3 lakh to 25 lakh.
Particulars Amount
1. Leave encashment received (A) …………..
2. (-) Exemption under Section (10AA)- (B) Least …………..
Of the following
(i) Amount notified by the government (2500000) ©
(ii) Actual leave encashment amount (D)
(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) …………..
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.
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