Is leave encashment taxable as salary?

Every salaried employee is entitled to leaves like casual, sick, earned or annual. Most of these leaves can be carried forward to the following years if the employee does not use them. Many enterprises and all government organisations allow an employee to carry these leave days forward up to their retirement or resignation. If such a facility exists, it is likely that at resignation or retirement you will be eligible to give the leave days back to the company and earn money instead. This process is known as leave encashment.

Tax on Leave Encashment

The following conditions are applicable while considering taxation on leave encashment:

• If a person is a government employee (be it state or central) – he/she will not have to pay any tax on the leave encashment income at the time of resignation or retirement.

• If a person is working in the private sector, the leave encashment after retirement or resignation is taxable as “Income from salary”. However, certain tax exemptions are provided under Section 10(10AA).

• If a person encashes leaves while still working in the company, then the amount is subject to taxation without any exemptions.

Tax Exemption under Section 10(10AA)

An employee in the private sector can claim exemption from income tax payment on the part of the leave encashment income after resignation or retirement. The exemption is provided as per the lowest of the below-stated amounts:

• Average salary (Basic + dearness allowance) of the last 10 months, prior to resignation or retirement

• The actual amount of leave encashment

• Rs. 3 Lakh

• Cash equivalent to the pending leave days (leave allowance*average salary per day)

For instance, Ms Nikita resigned her job from a private company after 18 years. She got a leave allowance of 40 days a year; this added up to 720 leaves in her complete term. Out of these, she took 500 holidays, leaving her with 220 days to encash. After calculation, it was found that she will receive Rs. 2,64,000 on retirement. her basic salary with DA in the last year of her service was Rs. 36,000. To calculate tax exemption on her leave encashment let us calculate the 4 of the above-stated amounts:

• Rs. 3,00,000

• Actual Leave Encashment – Rs. 2,64,000 Lakhs

• Average Salary of the last 10 months – Rs. 3,60,000

• Cash Equivalent of the pending leave days – 40*1200 – Rs. 48,000

So, Ms Nikita will get an exemption of Rs. 48,000 and her taxable salary will be (2,64,000-48,000) = Rs. 2,16,000.

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