Pradeep Gaur/Mint
Pradeep Gaur/Mint

The tax implications of encashing your unavailed leaves

When you encash your leaves, the amount is taxed as income from salary, but not always. Read on to know about tax relief in encashing leaves

If you are a salaried employee, you must be entitled to get various types of leaves. Privilege, medical and casual leaves are some of the common ones. Depending on your employer’s policies, either your leaves lapse—if unavailed till end of the financial or a calendar year—or get carried forwarded to the next corresponding year.

Some employers like to pay their employees in lieu of leaves, if they remain unavailed till end of the year, or at the time of leaving the job. However, any amount received against leave encashment is treated as ‘income from salary’, and taxed at slab rate of the employee. There are some exceptions. Read on to know about the tax liability of leave encashment.

Taxation rules differ according to whether you are employed with the private sector, the central government, or the state government. It also matters whether you are encashing your leaves while remaining in service, or at the time of retirement.

Leaves encashed during service: This is taxable, regardless of whether you are working in the government or the private sector. Even if an employee leaves a job due to resignation or termination, whether working with the government or a private employer, the amount received on account of leave encashment will be fully taxable in her hands.

Leave encashment at the time of retirement: Section 10(10AA) of the Income Tax Act, 1961, exempts leave encashment to some extent. Employees working in the central or state government offices have more privileges in this regard, than those working in the private sector. Money received by a government employee at the time of retirement against leave encashment, irrespective of its amount, is fully exempt from income tax.

On the other hand, there are certain limits up to which the amount of leave encashment is exempted from tax for a private sector employee. The least amount—calculated on basis of the following four conditions—is exempt from tax out of the total leave encashment received by the employee.

The first condition is the leave encashment amount actually received. Second, 10 months average salary, immediately preceding retirement. Third, amount equal to salary for the period of leave earned (leave earned not to exceed 30 days for every year of service). Fourth, Rs3 lakh, the maximum limit specified by the income tax department. Remember, salary means basic salary plus dearness allowance. Any other allowances and perquisites are excluded.

So, on the basis of above conditions let suppose at the time of retirement from a private job, if you get leave encashment of Rs4 lakh at retirement, with leaves balance of 375 days, and your average salary in the last 10 months was Rs35,000 per month. Then you are entitled to claim exemption of Rs3 lakh against leave encashment, which is the least of Rs4 lakh (actual amount received, Rs3.5 lakh from last 10 months salary, Rs3 lakh statutory upper limit). The remaining Rs1 lakh (Rs4 lakh minus Rs3 lakh, will get added to your ‘other income’ for the year and get taxed accordingly.