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Income Tax Calculation Guide to Salaried Employees' Leave Encashment

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By Arpit Kulshrestha
Tax Calculation on Leave Encashment for Employees

Tax Calculation for Leave Encashment

Accumulated leave would either be encashed in the service time or during the time of retirement or resignation. Leave encashed in the service time comes under tax and makes part of the income from salary. But the relief beneath income tax section 89 would be claimed. 

Leave encashment obtained during retirement/resignation is fully exempt for Central or State Government employees.

Leave encashment obtained by the non-government employee is exempt to the extent of lower of the mentioned below:

  • Amount reported via Government- Rs 3 lakh
  • Actual leave encashment amount 
  • The average salary for the last 10 months 
  • Salary per day x unutilized leave (considering a maximum of 30 days leave per year) for every year of completed service

The salary referred to above consists of the basic salary, dearness allowance, and commission based on a fixed percentage of turnover secured by the employee. 

For example, Gopal resigned from the firm XYZ. His monthly salary is Rs 1.5 lakh. He was qualified for 30 days of leave per year. His leave balance during the time of his retirement is 20 leaves. His leave encashment of Rs 1 lakh.

Thus the privileged leave encashment would be lesser of:

  • Amount reported via Government- Rs 3 lakh
  • Actual leave encashment amount – Rs. 1 lakh
  • Average salary of last 10 months – Rs. 15 lakh (Rs. 1.5 lakh x 10 months)
  • Salary per day x unutilised leave (considering maximum 30 days leave per year) for every year of completed service – Rs. 1.5 lakh / 30 days = Rs. 5,000 per day x 20 days = Rs. 1 lakh

Thus the Total Leave Encashment of INR 1 Lakh Shall Get Privileged

He now joins ABC company and spends 10 years before retirement. 2.4 lakh is his monthly salary. He was qualified to take 30 days' leave per year. His leave balance during his retirement is 100 leaves. His leave encashment of Rs. 8 lakh.

The exemption of Rs 3 lakh reported by the government is aggregated privileged during the lifetime of an employee. Thus the exempt leave encashment shall be lesser than.
  • Amount circulated via Government- Rs. 2 lakh (Rs. 3 lakh less Rs. 1 lakh claimed exempt earlier)
  • Actual leave encashment amount – Rs. 8 lakh
  • Average salary of last 10 months – Rs. 24 lakh (Rs. 2.4 lakh x 10 months)
  • Salary per day x unutilized leave (considering maximum 30 days leave per year) for every year of completed service – Rs. 2.4 lakh / 30 days = Rs. 8,000 per day x 100 days = Rs. 8 lakh
Thus the amount of the leave encashment privileged shall be Rs 2 lakh and Rs 6 lakh will be levied with tax. 

When the employer credits exceed Rs 30 days per year, the purpose of the leave encashment must be limited to 30 days per year. For example, for 10 years Anuradha served in the company. Company LMN credits 35 days per year as leave. Leave used via Anuradha in the service duration is 60 days. Her monthly salary stands at Rs 90,000. 8.7 lakh would be the leave encashment that she received. 

As the employer of Anuradha credits more than 30 days per year as leave, we need to compute the unused leave balance by limiting it to the max of 30 days per year leave.

Leave credits30 days
No of years of service10 days
Total leaves credit300 days
Leaves utilized60 days
Unutilised leave240 days

The Exempt Leave Encashment Would Be Less Than

  • Amount reported through the Government- Rs. 3 lakh 
  • Actual leave encashment amount – Rs. 8.7 lakh
  • Average salary of last 10 months – Rs. 9 lakh (Rs. 90,000 x 10 months)
  • Salary per day x unutilized leave (considering maximum 30 days leave per year) for every year of completed service – Rs. 90,000 / 30 days = Rs. 3,000 per day x 240 days = Rs. 7.2 lakh
Therefore, the amount of leave encashment privileged is Rs 3 lakh and Rs 5.7 lakh shall be levied with the taxation part. 

Question:

I obtained Rs 5 lakh as leave encashment as a part of the full and final settlement from the employer of my deceased husband. What amount shall be taxable beneath it?

If the employee dies prior to the leave encashment, then his legal heirs would obtain the total leave encashment on the grounds of the deceased. No income tax would be levied on the amount obtained by them.

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