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Sreeram Viswanath

Expert

Published on: Jun 24, 2026

Taxability Of Leave Encashment

An employee is accorded several annual leaves such as medical leave, gazetted holidays, casual leaves, and other similar kinds of leave. Based on the various employment policies, some of these leaves can be carried over to the next year, and a few of them must be utilized in the same year. Some employers facilitate the employee to encash such leaves as salary. In this article, we briefly discuss the Taxability Of Leave Encashment availed by employees.

Time of Encashment

An employee is usually entitled to claim encashment at the following stages:

  • During the course of service.
  • At the point of retirement/resignation.
  • At the point of termination.

Taxability

Encashment received by an employee would be treated as salary. As a result of it, leave encashment would be taxed in the hands of the employee as “Income from salary.” In some income tax provisions, leave encashment provides the taxpayer with the benefit of tax exemptions, which is further explained in the article. The taxability of encashment is calculated by reducing the exempted amount from the sum of money so received as encashment. For the purpose of income-tax, employees are categorized into the following:

  • Government employees
  • Non-Government employees

Taxpayers should note that leave encashment provided to family members on the death of the employee is exempted from taxation.

Encashment Received During Service

Encashment received during the course of service is entirely taxable in the hands of the Governmental and Non-governmental employees. However, the assessee is entitled to claim relief under

Section 89, if applicable. Section 89 of the Income Tax act consists of provisions that permit a taxpayer to claim exemptions for the receipt of arrears/advance salary, gratuity, compensation on termination of employment and payment of commutation of pension.

Leave Encashment on Retirement/Resignation

Leave encashed by a Government employee at the time of resignation or cessation of services is entirely exempt from income tax. On the other hand, leave encashed by any other employee in a similar scenario is exempt to a specified limit. The exemption will be the least of the following specified below:

  • Cash received for the leaves not availed. This will be derived by multiplying the period of earned leaves in months with the average monthly salary.
  • The average salary for the last 10 months.
  • Leave encashment received during retirement.
  • Rs 3,00,000.

Calculation of Average Monthly Salary

Average monthly salary is calculated by considering the monthly salary received by the employee in the last ten months immediately preceding the cessation of services. The components of calculation include basic pay, dearness allowance, and commission based on the fixed percentage of turnover achieved by the employee; and wouldn’t include any allowances or perquisites.
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Frequently Asked Questions

Common questions about Taxability of Leave Encashment for Employees Explained.

Leave encashment refers to the process of receiving monetary compensation for unused or accumulated leave days from an employer, typically upon retirement, resignation, or termination of employment.
Yes, leave encashment received by an employee is generally treated as a form of salary income and is subject to income tax. However, there are certain exemptions and deductions available, depending on the employee's status (government or non-government) and the circumstances of encashment.
Leave encashment received by government employees at the time of retirement or resignation is entirely exempt from income tax. However, if encashed during the course of service, it is fully taxable.
For non-government employees, leave encashment received at the time of retirement or resignation is exempt up to the least of the following: cash received for the unutilized leaves, average monthly salary for the last 10 months, leave encashment received, or Rs. 3,00,000.
The average monthly salary is calculated based on the monthly salary (including basic pay, dearness allowance, and commission based on fixed percentage of turnover) received by the employee in the last 10 months immediately preceding the cessation of service.
Yes, leave encashment received by both government and non-government employees during the course of their service is fully taxable. However, the assessee may be eligible for relief under Section 89 of the Income Tax Act.
Leave encashment received by family members upon the death of an employee is exempt from taxation, regardless of whether the employee was a government or non-government employee.
Yes, employees may be eligible for deductions or exemptions on leave encashment under Section 89 of the Income Tax Act, which provides relief for the receipt of arrears, advance salary, gratuity, compensation on termination, and commutation of pension.
Yes, leave encashment received by an employee during the course of their service, before retirement or resignation, is fully taxable as salary income, regardless of whether they are a government or non-government employee.
No, the exemption limit for leave encashment at the time of retirement or resignation does not vary based on the type of leave being encashed. The exemption is calculated based on the overall leave encashment amount received, subject to the specified limits mentioned in the article.