Leave Encashment | Meaning and Definition

What is Leave Encashment?

The amount of money that is received by an employee in return for unused paid leaves in a year is known as leave encashment. According to labor law, every salaried employee is entitled to a certain amount of paid vacation days from their employer. The amount of paid time off is decided by the employer. Many companies also allow employees to carry forward paid leaves if they are not used in a single year, resulting in an unutilized leave balance in their leave quota at the time of departure or retirement. At the time of off-boarding, the company is required to reimburse the employee for unutilized paid leave; this payment is known as Leave Encashment. 

Benefits Of Leave Encashment

  •   If the employee is in service, the proceeds obtained for leave encashment are charged.
  •   If you leave a job owing to dismissal or resignation, the sum collected on account is totally payable in your hands, whether you work in the private or public sector.
  •  Under income tax laws, the value or amount earned toward leave encashment is treated as payroll income and taxed under a slab.

Leave encashment rule 2023

The leave encashment rule for non-government employees is exempt up to a certain limit. This limit was 3 lakh as set in 2002 owing to the low salary of employees but the limit was recently revised to 25 lakh owing to a substantial increase in the salary of employees.

Any payment received at the time of retirement as leave encashment amount up to 25 lakh is exempted from Income tax but beyond this amount is taxable under the salary head of Income tax.

Leave encashment of various leaves

The different types of leaves vary from organization to organization. Here are some common types of leaves provided by organizations

1. Casual leave

Casual leaves are available for a short time that usually varies from 7 to 10 days. Employees may avail of these leaves for personal reasons. Encashment of casual leaves vary from organization to organization.

2. Earned leave or privilege

An employee can avail of earned leaves with prior notice to the designated authority. These leaves become eligible for encashment after a certain period. This policy varies from organization to organization.

3. Medical leaves

Generally employees take medical leave when they cannot perform duties towards the organization due to poor health conditions. Encashment of medical leaves may vary according to the organization’s policy.

4. Holiday leaves

Holidays may be granted to employees and no salary would be deducted for that. The number of holidays provided may vary from organization to organization.

5. Maternity leaves

Maternity leaves are provided to female employees who are pregnant ranging from 12 to 26 weeks. An employee can ask for an extension but no salary would be provided for that period. These leaves are not available for extension.

6. Sabbaticals

Employees can take leaves for upskilling and expand their knowledge base. They can enroll for a course to learn something and employers may reimburse those leaves.

Taxation on leave encashment

Here are the taxation rules on leave encashment in various situations:

1. Leave encashment received during service

Tax on leave encashment depends on when it is received. If an employee receives leaves during his tenure it is fully taxable under the salary head of Income tax. However you can claim some tax benefits under Section 89 of Income tax. For this you can fill up a form to claim this deduction.

2. Leave encashment at the time of termination

Here are the conditions under which an employee can claim tax deduction under leave encashment at the time of termination

It usually depends in which sector you are working.

1. State and Central government employees- Fully tax-exempt

2. Non-government employees- Partly exempt and partly taxable

This exemption is based on Section 10 of Income tax

3. Legal heir of a deceased employee- In case of death of the employee the legal heir will receive the amount of legal encashment received by the legal heir of the employee is fully exempted from Income tax. 

Leave Encashment Calculation

The formula for calculating leave encashment exemption of a non-government employee

“Proposed limit of income tax exemption for a non-government employee has been increased from 3 lakh to 25 lakh.

Particulars                                                                                                                                                                                     Amount


1. Leave encashment received (A)                                                                                                                                …………..

2. (-) Exemption under Section (10AA)- (B) Least                                                                                              …………..

Of the following


(i) Amount notified by the government (2500000) ©

(ii) Actual leave encashment amount (D) 

(iii) Average salary of last 10 months (E)

(iv) Salary per day* unutilized leave (considering

Maximum 30 days in a year for completed service)


Leave encashment taxable (A)-(B)                                                                                                                               …………..

Salary for this purpose includes basic salary, dearness allowance and commission based on fixed percentage of turnover by employees
For example- If an employee has received 500,000 after first resignation as encashment balance then next computation will be done on the amount of 20,000,00. A total of 25,000,00 is exempted under Income tax.
Let’s understand how it is made using a simple illustration.
Mr. X is retiring after 15 years of service.
Mr. X was entitled to 30 days of paid leave per annum from his  employer i.e, overall 600 days of leave during his entire service (20*30)
Out of the same Mr. X had already utilized 230 leaves and is left with 370 leaves. Mr. X was drawing basic salary along with the dearness allowance of 30000 per month and received 30000/30*370= 370000 as leave encashment calculated of 370 days.
Particulars                                                                                                                             Amount
Leave encashment received                                                                     3,70,000
(-) Exempt                                                                                                      2,20,000
Least of the following
(i) Amount notified by govt                                                                       25,00,000
(ii) Actual leave encashment                                                                    3,70,000
(iii) Average salary for 10 months=30000*10                                          3,00,000
(iv) 1000* (30 days* 15 years of service minus                                       2,20,000
 230 Days of utilized leave)
Leave encashment taxable=2,20,000
Based on the employer’s policy an employee may decide when to encash the leaves. It can be during the tenure or at the time of resignation which may help in tax saving.

FAQs (Frequently Asked Questions)

Leave encashment refers to the money that an employee receives for their unutilized leaves in an organization.

You can either encash or clear your leaves at the time of termination or layoff.

The other terms used for leave encashment are holiday pay and vacation days.

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