How leave encashment exemption works under Section 10(10AA)
When you leave a job — by retiring or resigning — many employers pay out your unused "earned leave" balance in cash. This payout is called leave encashment, and under Section 10(10AA) of the Income Tax Act, part or all of it can be exempt from tax depending on who employs you and why you're receiving the payment.
Government vs non-government employees
If you're a Central or State government employee, leave encashment received on retirement or resignation is fully exempt from tax, with no upper limit. Non-government employees (private sector, PSU, etc.) get a more limited exemption, calculated as theleast of four separate limits:
- Limit 1: a fixed lifetime exemption cap, applied cumulatively across every employer you've worked for in your career — not a fresh cap per job
- Limit 2: the actual leave encashment amount you received
- Limit 3: 10 months' average salary (basic + DA, where DA counts for retirement benefits), based on the 10 months immediately before you leave
- Limit 4: the cash equivalent of leave you actually earned but didn't use, capped at 30 days for every year of completed service
Whichever of the four is smallest becomes your exempt amount; the balance of what you actually received is added to your taxable salary for the year.
Why encashment "during service" is fully taxable
The exemption under Section 10(10AA) only applies when leave encashment accompanies youleaving your job — through retirement or resignation. If you encash leave while you're still employed (for example, an employer that lets you cash out unused leave at each year-end), that amount is fully taxable as salary income, with no exemption available at all. The four-limit calculation above simply doesn't apply to this case — the entire amount you receive is added to your taxable salary.
The ₹25 lakh lifetime cap is per employee, not per job
A detail that catches many people off guard: the lifetime exemption cap (limit 1 above) is not reset every time you change jobs. If you've already claimed leave encashment exemption with a previous employer, that amount reduces how much exemption you have left to claim with your current or future employers — the cap applies across your entire working life, not per employment. In practice, if you don't have a precise record of exemption already claimed in earlier jobs, it's worth checking your Form 16s or asking your HR/payroll team before assuming the full cap is still available to you.
Worked example
Say your average basic + DA for the 10 months before retirement is ₹60,000/month, you're encashing 90 days of leave after 10 years of service, and your company credits 30 leave days a year. The actual amount received works out to ₹60,000/30 × 90 = ₹1,80,000. Limit 3 (10 months' salary) comes to ₹6,00,000, and limit 4 (leave actually earned, capped at 30 days/year × 10 years = 300 days, against 90 days encashed) also works out to ₹1,80,000. Since the lifetime cap is far higher than all of these, the smallest of the four is ₹1,80,000 — so the entire amount is exempt and nothing is taxable. Change any of the inputs above and the calculator re-ranks the four limits instantly, highlighting whichever one is now binding.