Concept of Leave Encashment
Every salaried person as per labor law is entitled to at least a minimum number of paid leave every year. However, it is not necessary that an individual employee utilizes all the leave he is entitled to a year. In actuality, most employers allow the employees the option of carrying forward such unutilized paid leaves. This would leave the employee with an accumulated unutilized leave balance at the time of retirement or resignation from the company as the case may be. This compels the employer to compensate for the unutilized paid leave of the employees. This concept is better known as leave encashment.
Now that we have in brief, understood what leave encashment is, the next step is to understand how it is taxed in the hands of the recipient
Taxation of Leave Encashment
Leave encashment received during the service the Saved leave can either be encashed during service or at the time of retirement or resignation. Any leave encashed during service is fully taxable and forms part of ‘income under the head of Salary’. However, relief under Section 89 can be claimed
Leave encashed at the time of retirement or resignation
Leave encashment received at the time of retirement or resignation, may be either fully or partially exempt depending upon the category that an employee falls under. This has been elaborated further below:
- If it is received by CG or SG (Central or State Government) employee at the time of retirement or resignation is fully exempt
- received by legal heirs of the deceased employee is fully exempt.
- received by Non-Government employee are exempt based on the computation provided under Section 10(10AA) (ii) and balance amount if any is taxable as ‘income from salary’
Compute the amount of taxable leave encashment.
Steps for computing Cash equivalent of unveiled leaves as per income tax
➔ Step-1: Leave actually allowed or 30 days/year whichever is less
➔ Step-2: Leave actually taken
➔ Step-3: (step1 – step2) x average monthly salary/30
Meaning of salary
Basic + DA (Forming Part of retirement benefit) + Comm. based on turnover.
The average salary of the last 10 months preceding the date of retirement.