Both government and private employees are entitled to various types of leave such as casual leave, sick leave, privileged leave and earned leave during their course of employment. While some of these leaves can be carried forward to the next year, others cannot. Employees can also opt for encashment of these leaves if they haven’t availed them.
However, the number of leaves that can be availed and encashed is decided by the employer while the amount received is determined by the tax implications and whether the leave is encashed during the course of employment or at the time of retirement. The taxation is again dependent on whether an individual is a government or non-government employee.
Additional Reading: Tax truths about leave encashment
Let’s look at the different scenarios.
Leave encashment during employment
If an employee opts for encashment of leaves during his course of employment, the entire amount would be taxable under the head “Income from salary”. However, at the time of filing for returns, exemption is allowed on a certain amount.
Additional Reading: Tips To Make Your Salary Extremely Tax-Efficient
Leave encashment at the time of retirement
At the time of retirement, an employee is entitled to exemptions under Section 10(10AA). However, the amount exempted is different for government and non-government employees.
While leave encashment is completely tax free for government employees at the time of retirement, it is partially exempted from tax in case of non-government employees.
The least of the following is exempted:
- Actual leave encashment received
- Average monthly salary of the last 10 months
- The maximum amount specified by the government i.e. Rs. 3,00,000
- Cash equivalent of earned leaves (to a maximum of 30 days) for every year of service completed
The remaining amount received would be taxable as per the Income tax slab rates.
Following are the points to be kept in mind with regards to taxation of leave encashment
- Salary, including basic salary, dearness allowance and commission, received as a fixed percentage of the yearly turnover, are considered for taxation.
- Average salary of 10 months refers to the salary received in the last 10 months prior to retirement.
- If the employee had encashed leaves in any of the previous year/years and availed exemption for it, the limit of Rs. 3,00,000 would be reduced by the amount of exemption claimed earlier.
- In case of resignation by the employee, the taxation applicable would be the same as that for retirement.
- In case of death of the employee, the leave encashment would be received by his/her legal heir or nominee. The amount would be completely exempted from taxes for both government and non-government employees.
Additional Reading: LTA Explained
Don’t let the taxation of your various forms of income come as a shock to you. Instead, you could proactively educate yourself about how your money is taxed and also learn about the measures you can take to minimise your tax incidence.