If you opt for the option for leave encashment, the amount so received as “Leave encashment” would be liable to be taxed under the category “Income from Salary” and attracts income tax. However, tax exemption is allowed only if the leave encashment is being done at the time of retirement or resignation, it is immaterial whether retirement is voluntary or due to superannuation. There is no exemption allowed if the leave encashment is during the tenure of service, and the entire leave encashment is charged.
Tax Exemption for Leave Encashment is dealt under Section 10(10AA) of Income Tax Act and the tax exemption is divided into the following two categories:
Every employee enjoys various types of leaves viz medical leave, casual leaves, gazette holidays, earned leaves, etc. Generally the number of leaves is fixed by the employer or the Company for every year. A number of companies or employers facilitate their employees to carry forward their leaves to the next year whereas some employers do not facilitate their employees with this option. In cases where the leave cannot be carried forward to the next year, the companies provide the option of encashment i.e. getting the salary for the number of days that were to be availed as leaves, but were not.
Government Employees
Government employees include only the Central and State Govt. employees. The government employees enjoy full tax exemption on amount received as leave encashment at the time of resignation or retirement.
Non-government employees
Non-Govt employees can also claim tax exemption for leave encashment on accumulated leaves at the time of resignation or retirement. From the Total Amount received as Leave Encashment you need to deduct the amount exempted and the remaining i.e. balance amount will be taxed as per the slab rate under which the income falls. The least amongst the below mentioned four points is eligible for tax exemption on Leave Encashment:
i. Total amount received as leave encashment
ii. Average salary for 10 months (wherein average salary is calculated on the basis of average of 10 months salary drawn for months immediately preceding the employee’s retirement or resignation).
iii. Fixed amount of Rs 3,00,000 as specified by the government. (However, if the employee has earlier also claimed a leave encashment in respect of this amount of Rs 3,00,000 then the 2nd time the amount earlier paid as leave encashment will be deducted from Rs 3,00,000 )
iv. Cash equivalent i.e. the salary for the days that were not availed as leave and the calculation will be based on the assumption of a maximum 30 days leave per year.
It is notable that any amount of leave encashment received by the Legal Representatives or family members of an employee after his death is exempted from tax.
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