Employees in the private sector now face a revised Rs 25 lakh limit on tax-exempt leave encashment at retirement, with specific rules differentiating government and non-government payouts, impacting retirement benefits and tax planning strategies.
Retirement can bring a last payout that many employees overlook: money for unused leave. Known as leave encashment, it is the cash value of earned days off that were not taken during service. According to Zee Business, the tax treatment depends on two things in particular: whether the employee worked for the government or the private sector, and when the payment is made.
For Central and state government employees, leave encashment received at retirement is fully exempt from income tax. The position is different for private-sector and other non-government employees, who can claim only a limited exemption. Legal Clarity and TaxClue both note that the relief is governed by section 10(10AA) of the Income Tax Act and is available under both the old and new tax regimes, so there is no need to switch tax systems to benefit from it.
For non-government employees, the exempt amount is the lowest of four figures: the actual leave encashment received, Rs 25 lakh, 10 months’ average salary, or the cash value of eligible unused earned leave. The Rs 25 lakh ceiling was raised with effect from 1 April 2023, according to the reports. Average salary is worked out using pay from the last 10 months before retirement and usually includes basic pay, dearness allowance if it counts towards retirement benefits, and commission based on a fixed turnover-linked formula. For leave calculation, the law limits earned leave to 30 days for each completed year of service.
There are important exceptions. Leave encashment paid while an employee is still working is generally fully taxable, even though retirement-related payments may qualify for relief. If the payment is made to legal heirs after an employee’s death, the Income Tax Department says it is exempt. The lifetime cap also matters if someone has worked for more than one non-government employer: any exemption already used earlier reduces what remains available, and the overall limit stays capped at Rs 25 lakh across such payments.
Disclaimer: This article is intended to inform and educate, not to recommend or endorse any financial product, investment or strategy. Please consider your own financial circumstances and seek professional advice where appropriate before making financial decisions.
