When an employee is in service, he is allowed various types of leaves like medical leave, casual leaves, Gazetted holidays etc. In case an employee does not avail all the leaves which were allowed to him, he can encash those leaves and earn his salary for the same. However, it largely depends upon the Leave Encashment policy of the employer. He may either allow you to carry forward a certain type of leaves and encash them or may prefer you take your leaves as you go or else these may lapse on a fixed date. Any amount received in lieu of leaves accumulated is referred to as Leave Encashment and is taxed under the head ‘Income from Salary’. Tax treatment of leave encashment is shown below:

Leave encashment received	Govt Employees	Non-Govt Employees
during the period of service	Fully taxable	Fully taxable
at the time of retirement or resignation (other than on account of termination)	Fully exempt	Exemption is least of the following: 1) ₹3,00,000 (maximum limit) 2) Leave encashment amount actually received 3) 10 months’ salary (on the basis of average salary of last 10 months) 4) Cash equivalent to leaves to the credit of employee at time of retirement
at the time of termination of employee	Fully taxable	Fully taxable

Note:

• Here, salary means Basic Pay + Dearness Allowance (forms part of retirement) + Commission on turnover/sales;
• Cash equivalent to leaves to the credit of employee at time of retirement is = {(A X B) – C} X D;

Where, A= Number of completed year of service (excluding part of the year) B= Number of leave credited each year (Subject to maximum of 30 leave per year) C= Number of leave taken or leave encashed during period of employment D= per day salary on the basis of Average salary for last 10 months   Let us understand the tax treatment of leave encashment with the help of an example: Mr. A retired on 1.12.2017 after 20 years 10 months of service, receiving leave encashment of ₹5,00,000. Other details of his salary income are: Basic Salary: ₹20,000 p.m. Dearness Allowance: ₹10,000 p.m. (60% of which is for retirement benefits) Leave availed during service: 480 days He was entitled to 30 days leave every year. Least of the following amount is exempt from tax out of the leave encashment (₹5,00,000) received:

• ₹3,00,000 [maximum limit]
• ₹5,00,000 [Actual leave encashment received]
• ₹2,60,000 {(20,000*10)+(60% of 10,000)*10}/10 [10 months’ salary]
• ₹1,04,000 {(20*30)-480}*(26000/30) [Cash equivalent to leaves to the credit of employee at time of retirement]

  Therefore, ₹1,04,000 will be exempt from tax and rest ₹3,96,000 will be taxable out of the leave encashment received. Important points to note:

• Where leave encashment is received from two or more employers in the same year, then the aggregate amount of leave salary exempt from tax cannot exceed ₹3,00,000
• Where leave encashment is received in any earlier year from a former employer and again received from another employer in a later year, the limit of ₹3,00,000 will be reduced by the amount of leave salary exempt earlier.
• Leave encashment received by the legal heirs (family members) after death of the employee is not at all taxable in the hands of his legal heirs.