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Leave Encashment – Meaning, Rules, and Benefits Explained

What Is Leave Encashment?

Leave Encashment is when your job lets you swap those unused vacation days piling up for extra cash instead—like trading your saved-up beach time for a fatter paycheck. Maybe you couldn’t take time off, or you’d rather have the money; companies often offer this as an option (with some rules) to keep leave balances from blowing up or to give employees a liquidity boost. It’s the “I’ll take money over margaritas” deal, but taxes might nibble a chunk.

Eligibility For Leave Encashment

Entitlement conditions differ by organization and are governed by legislation/acts for accessing awards. It specifies whether legality is needed by the employee to be considered for leave encashment.

Unutilized paid leaves are due to the employee as per the company’s leave policy.
Encashment of leave in the organization is allowed under the HR policies.
Many companies provide leave encashment when an employee retires, resigns, or meets certain criteria.
For encashment, the last basic salary received by the employee and the dearness allowance will be used.
Sick leave, casual leave, or similar types of leave have no encashment facility.

Taxability Of Leave Encashment

Leave Encashment Taxation in India is entirely dependent on the sector to which an employee belongs and the time of encashment.

Government Employees: The cash value of earned leaves is entirely exempt from income tax for government employees, whether such cash value is received during service or upon retirement.
Private Sector Employees: For private sector employees, the cash equivalent of leave encashment is taxable subject to other exemptions under Section 10(10AA) of the Income Tax Act.
During Service: If the cash equivalent of leave is received during the term of employment, it forms part of the salary and is taxed at normal rates per the requisite income tax slab.
Upon Retirement or Resignation: In this case, the provision states that up to Rupees 25 lakhs can be claimed as exempt, and any amount exceeding the limit is taxed according to the employee’s income tax slab.
On Termination or Death: In the case of termination or death, the treatment may differ and depend on the laws governing the employment contract, where entitlements differ. In-depth matters must, however, be consulted with a tax professional.

Computation Of Amount Leave Encashment

Calculating the amount of leave encashment may differ based on the policy of the specific organization. However, a general formula is applied for the indication of the payout.

Formula: (Basic Salary + Dearness Allowance) / 30 x Number of Leave Days to be Encashed.

Some companies, however, refer to 26 working days instead of 30 for calculating the pay per day.
The period for the encashment of the remaining leaves is decided by company policy.
Bonuses, allowances, HRA, etc., usually do not go into encashment calculations.
Deductions or limits may be set by some organizations to manage encashment costs.

Leave Encashment at Different Employment Stages

Leave encashment timing decides the amount to be paid and the tax treatment of that amount. These include:

During Employment: Many companies allow some periodic leave encashment on an annual basis.
At Resignation: Encashment of accrued leave shall be given to the employees except for the last day on which an employee works.
At Retirement: Full tax exemption is given to government employees, while private employees enjoy limited exemption.
On Termination or Death of an Employee: Leave encashment goes to the employee, and in case of death, to his legitimate heirs.
Under Voluntary Retirement Scheme: Leave encashment is part of the retirement package but may be subject to exemptions.