Many companies provide a fixed quota of paid leaves to their employees annually, and in case these leaves are not fully utilised, employees may have the option to convert them into monetary compensation. This policy is known as leave encashment.
Now the implementation of this policy varies from employer to employer. But in case your company has such a policy in place, and you’re planning to encash unused leaves, you will most likely have to pay tax on this additional income.
Let’s understand the details.
First of all, the amount received against unused leaves is added to your gross salary and mentioned in Form 16 as ‘Cash equivalent of leave salary encashment under section 10 (10AA).’
Now let us figure out when is the leave encashment amount taxable (or exempt).
The taxability of leave encashment depends on two things:
- First, whether you are a government employee or not, and
- Second, when did you receive this amount.
Read the below table.
If you are a non-government employee and have received leave encashment upon retirement or resignation, the exempted amount is equal to the lowest of the following:
- Cash equivalent of unused leaves (in months) x last 10-month average salary
- The total amount of last 10 months salary
- Actual amount of leave encashment received from the company
- ₹25,00,000
Here the average monthly salary will include both basic component and dearness allowance.
Let’s take an example to understand this better.
Suppose you receive ₹9L as leave encashment at the time of retirement.
- Actual leave encashment received: ₹9,00,000
- Number of unused leaves: 120 days
- No. of years served: 25 years
- Last 10-month average salary (Basic + DA): ₹2,00,000
So the exempted amount will be the lowest of:
- 120 days ÷ 30 × ₹2,00,000 = ₹8,00,000
- 10 × ₹2,00,000 = ₹20,00,000
- Actual amount received = ₹9,00,000
- Maximum amount set by government = ₹25,00,000
The least amount is ₹8,00,000, so the maximum exemption will be ₹8,00,000.
Hence, the taxable component will be ₹9,00,000 - ₹8,00,000 = ₹1,00,000.
Now, let’s see how to report leave encashment amount in your ITR.
Leave encashment amount is reported under the head ‘Income from salary.’
As mentioned earlier, the total leave encashment amount will be added to your gross salary and you’ll have to claim the exempted amount as an allowance under Section 10(10AA).
The balance amount will be taxed at your applicable slab rates, just like other salary components.
If you have any queries on the taxability of leave encashment, you can comment your questions below.