Leave Encashment

About leave encashment

Leave encashment is the cash payment your employer makes for the unused earned leave you carry on your books when you resign, retire, or are otherwise separated. It converts the days you did not take into a salary multiple, and Section 10(10AA) of the Income Tax Act 1961 lets a non-government employee shelter part of that lump sum from tax. The exemption ceiling was raised from 3,00,000 rupees to 25,00,000 rupees with effect from 1 April 2023 by CBDT notification number 31/2023, recognising that the long-standing 3 lakh cap had been set in 2002 and had become trivial against actual salary scales.

The calculator estimates the gross payment for your unused leaves, then applies the four-way minimum that the Act requires for private-sector retirements. For central or state government employees, the entire amount is tax-free regardless of the four conditions: a distinction often missed in payroll comparisons between sectors.

How the calculation works

The gross encashment is simply the per-day salary multiplied by the number of unused earned leaves. The "average monthly salary" the law refers to is the average of basic plus dearness allowance plus commission (if it is a fixed percentage of turnover) for the 10 months immediately preceding the date of retirement. House rent allowance, conveyance, special allowances, and one-off bonuses are excluded.

per_day_salary = average_monthly_salary / 30
gross_encash   = per_day_salary x unused_leaves

For private employees, exempt = MIN of:
  (1) actual leave encashment received
  (2) 25,00,000 (statutory cap, April 2023)
  (3) 10 x average monthly salary (last 10 months)
  (4) per_day_salary x 30 x completed_years_of_service

Taxable = gross_encash - exempt

• 30-day month convention: the law fixes the divisor at 30, not the actual calendar month.
• Cap is lifetime: 25,00,000 is the aggregate across all past employers; switching jobs does not reset it.
• Completed years: only full years count for condition (4); a fraction of a year is dropped.
• Government employees: full exemption under section 10(10AA)(i) bypasses all four tests.

Worked example

Private employee retiring at average monthly salary of 60,000 rupees, with 60 days of unused earned leave at exit and 10 completed years of service.

1. Per day salary: 60,000 / 30 = 2,000 rupees.
2. Gross encashment: 2,000 x 60 = 1,20,000 rupees.
3. Condition 1: actual received = 1,20,000.
4. Condition 2: statutory cap = 25,00,000.
5. Condition 3: 10 x 60,000 = 6,00,000.
6. Condition 4: 2,000 x 30 x 10 = 6,00,000.
7. Exempt amount: min(1,20,000; 25,00,000; 6,00,000; 6,00,000) = 1,20,000.
8. Taxable: 1,20,000 - 1,20,000 = 0.

Scenario comparison

Common pitfalls

• Encashment during service is fully taxable. Section 10(10AA) exemption only applies at retirement or resignation. If you encash leaves while still on the rolls, the entire amount is added to salary income.
• Lifetime cap, not per-employer. The 25 lakh cap aggregates across all jobs. If you used 18 lakh from a previous employer in 2024, only 7 lakh is available now.
• Wrong salary base. Many people use CTC or current gross. The Act specifies basic + DA + fixed-commission only, averaged over the 10 months before exit. Using CTC inflates condition (3) and overstates the exemption.
• 30 days per month, not actual. The law fixes the per-day rate by dividing by 30. Treating 31-day months as 31 days underweights the rate.
• Forgetting the section 89(1) relief. If the lump sum pushes you into a higher tax bracket, you can claim relief under Section 89(1) by spreading the taxable portion notionally over the years of service. File Form 10E before the ITR.
• Government definition. Only Central and State government employees (and Defence) get the unconditional exemption. Statutory corporations, PSUs, and government schools are private for this section unless the rules specifically say otherwise.

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Frequently asked questions