While leave encashment is often seen as a valuable retirement benefit, the amount that is exempt from tax depends on whether you’re a government or private-sector employee and the conditions laid down under the Income Tax Act.
For Assessment Year (AY) 2026-27, knowing the exemption limits and calculation rules can help you estimate your tax liability and avoid difficulties when filing your income tax return (ITR).
Here’s how the leave encashment tax rules for AY 2026-27 work and how much exemption salaried employees can potentially claim.
How much exemption can salaried employees claim?
The tax treatment of leave encashment for salaried employees depends on whether the employee is a government employee or a non-government employee, and also on the timing of receipt.
Leave encashment received during the course of employment is generally taxable, whereas leave encashment received at the time of retirement or resignation may qualify for exemption, subject to prescribed conditions.
Leave Encashment Received During Service is Fully Taxable – Where leave encashment is received by an employee during the period of service, the amount is generally treated as a taxable salary receipt and is fully taxable in the hands of the employee.
Full Tax Exemption for Government Employees on Retirement – In the case of Central or State Government employees, leave encashment received at the time of retirement, superannuation, resignation, or otherwise is fully exempt from tax under section 10(10AA) of the Income-tax Act.
Accordingly, the entire amount received towards encashment of unutilised earned leave is not chargeable to tax.
Exemption for Private Sector and Other Non-Government Employees
For private sector employees and other non-government employees, leave encashment received at the time of retirement is exempt under section 10(10AA), subject to the least of the following amounts, according to CA Dr Suresh Surana.
- Actual leave encashment amount received or
- Rs. 25 lakhs, being the maximum monetary ceiling prescribed or
- Average salary of 10 months immediately preceding retirement or
- Cash equivalent of unutilised earned leave standing to the employee’s credit at the time of retirement, calculated based on the average salary of the last 10 months.
Restriction on Leave Accumulation for Exemption Calculation: For computing the exemption, the leave entitlement considered cannot exceed 30 days of earned leave for every completed year of actual service rendered to the employer from whom the employee has retired.
Any excess leave accumulation beyond this prescribed limit is ignored for exemption purposes.
Are leave encashment benefits available under both the old and new tax regimes?
Leave encashment benefits are available under both the old and new tax regimes, subject to the conditions prescribed under Section 10(10AA) of the Income-tax Act, says CA Dr Suresh Surana.
The new tax regime under Section 115BAC of the Income-tax Act, 1961, does not specifically withdraw the exemption for leave encashment; therefore, eligible taxpayers can continue to claim it irrespective of the regime chosen.
Where should taxpayers report leave encashment income in their ITR, and what documents should employees retain to support their exemption claim?
In the ITR form, the Leave encashment on retirement should be disclosed under Schedule S – Details of Income from Salary, by including the amount of leave encashment in the gross salary, and then the exemption may be claimed under the column ‘Less: Allowances to the extent exempt under section 10’, to the extent eligible.
An extract of the relevant schedule has been provided below for reference.
Employees claiming exemption on leave encashment should retain adequate documentary evidence to substantiate the claim, particularly in case of future tax scrutiny or verification. Key documents include:
Form 16 issued by the employer reflecting leave encashment and tax treatment,
Employer’s computation sheet/salary breakup showing the leave encashment component,
Retirement, resignation, or superannuation letter evidencing cessation of employment,
Leave encashment calculation statement issued by the employer showing the computation of unutilised leave and the amount paid.
Salary records of the preceding 10 months, especially for non-government employees, where the exemption is linked to the average salary,
Proof of earlier exemption claimed, if any, since the Rs. 25 lakh exemption limits for non-government employees are cumulative over a lifetime. (Note: The government increased the tax-free leave encashment limit for non-government employees from Rs 3 lakh to Rs 25 lakh, effective April 1, 2023).
Employees should preserve these records for a reasonable period even after filing the return, as the tax department may seek clarification where there is a mismatch between salary disclosures, exempt income claimed, and information reflected in Form 16, AIS, or employer reporting.
Disclaimer: This article is for informational purposes only and does not constitute professional tax advice. Tax laws and regimes are subject to frequent changes by the government. Readers should verify details with official Income Tax Department notifications or consult a Chartered Accountant before making any financial decisions.
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