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