What about PSU and public-sector bank employees?
Working for a government-owned organisation does not automatically make someone a Central or State Government employee for this purpose. PSU employees, public-sector bank employees and employees of government-owned companies are generally treated as non-government employees and are subject to the prescribed calculation and ₹25 lakh limit.
Leave Encashment Received by Non-Government Employees
Under Section 10(10AA)(ii), employees other than Central or State Government employees can claim limited relief on leave encashment received at retirement, resignation or otherwise leaving employment.
The eligible amount is the lowest of the actual payment received, ten months’ average salary, the value of eligible unused earned leave and the remaining amount from the ₹25 lakh cumulative limit. Any amount above the eligible relief is taxable as salary and may be considered by the employer while deducting TDS under Section 192.
Also Read: Taxable, Non-taxable and Partially Taxable Components of Salary in India
How is Leave Encashment Tax Relief Calculated?
For a non-government employee, the eligible tax relief is the lowest of the following four amounts:
| Amount considered | How it is calculated |
|---|---|
| Actual leave encashment received | The amount paid by the employer |
| Ten months’ average salary | Average monthly salary x 10 |
| Value of eligible unused earned leave | Average monthly salary x eligible leave balance in months |
| Remaining overall limit | ₹25 lakh minus any leave encashment relief claimed earlier |
Any amount received above it is treated as taxable salary income.
Salary and Leave Used in the Calculation
For this calculation, average salary means the average of the employee’s salary for the 10 months immediately before leaving the organisation.
It generally includes:
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Basic salary
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Dearness allowance, where it forms part of retirement benefits
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Commission calculated as a fixed percentage of turnover
Other payments, such as bonus, house rent allowance, overtime pay and variable allowances, are generally not included.
The eligible leave balance is also limited. Earned leave cannot be counted at more than 30 days for each completed year of service with the current employer. Leave already taken or encashed must be deducted from this balance.
Eligible unused leave = Leave earned for completed service − Leave already used or encashed
This calculation is based on service with the employer from whom the employee receives the leave encashment.
Section 10(10AA) Calculation Example
Suppose a non-government employee receives ₹9 lakh as leave encashment after leaving the organisation. Assume that they have not claimed any leave encashment tax relief earlier.
Their details are:
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Average monthly salary for the last 10 months: ₹1.2 lakh
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Completed years of service: 18 years
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Eligible unused earned leave: 180 days or 6 months
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Actual leave encashment received: ₹9 lakh
The eligible tax relief will be the lowest of the following:
| Amount considered | Calculation | Amount |
|---|---|---|
| Actual leave encashment received | Amount paid by the employer | ₹9 lakh |
| Ten months’ average salary | ₹1.2 lakh × 10 | ₹12 lakh |
| Value of eligible unused leave | ₹1.2 lakh × 6 months | ₹7.2 lakh |
| Remaining overall limit | ₹25 lakh − earlier relief claimed | ₹25 lakh |
The lowest amount is ₹7.2 lakh. Therefore:
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Amount receiving tax relief: ₹7.2 lakh
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Taxable leave encashment: ₹9 lakh − ₹7.2 lakh = ₹1.8 lakh
This taxable amount is added to the employee’s salary income and taxed at the applicable rate.
What Is the Maximum Leave Encashment Tax Relief Limit?
For non-government employees, the maximum monetary limit for leave encashment tax relief is currently ₹25 lakh. This is only one part of the prescribed calculation; the actual relief may be lower depending on the amount received, average salary and eligible unused earned leave.
Why Do Some Sources Mention a ₹3 Lakh Limit?
The earlier tax-relief limit for non-government employees was ₹3 lakh. Notification No. 31/2023 increased it to ₹25 lakh with effect from 1 April 2023.
The notification was issued on 24 May 2023, but the revised limit applies retrospectively from 1 April 2023. The change applies to non-government employees; eligible Central and State Government employees continue to receive full tax relief without this monetary ceiling.
Is the ₹25 Lakh Limit Available for Every Employer?
No. The ₹25 lakh amount is a cumulative limit, not a separate limit for each employer or each employment. Relief claimed in earlier years must be deducted from the available limit, and payments received from multiple employers must be considered together.
For example, if an employee has already claimed ₹6 lakh as tax relief in the past, the remaining limit will be:
₹25 lakh − ₹6 lakh = ₹19 lakh
However, ₹19 lakh does not automatically become tax-free. The employee must still apply the lowest-of-four calculation, and the actual relief may be lower.
Important: Changing employers does not reset the ₹25 lakh limit. Employees should keep records of any leave encashment tax relief claimed earlier.
Is Leave Encashment Tax Relief Available Under Both Tax Regimes?
Yes. Leave encashment tax relief is available under both the old and new tax regimes. The ₹25 lakh ceiling, the lowest-of-four calculation and the distinction between government and non-government employees remain the same in both regimes.
What changes is the tax treatment of the taxable portion, if any. Under the old regime, an employee may be able to reduce total taxable income further by claiming deductions such as Section 80C, Section 80D and HRA, where applicable. Under the new regime, many of these deductions are not available, so the final tax outgo may differ even though the leave encashment exemption itself remains the same.
How to Claim and Document Leave Encashment Tax Relief?
Leave encashment received when leaving employment must be reported as part of salary income. The full amount and the eligible tax relief are shown separately so that only the remaining balance becomes taxable.
Step 1: Verify the Amount in Form 16
Check Part B of Form 16 and your full-and-final settlement statement. The employer should report the complete leave encashment amount as part of salary and show the eligible relief separately under allowances exempt under Section 10.
If the figures are missing or incorrect, compare them with your salary slips, leave records and the calculation provided by your employer. Information about salary allowances and their exempt portions is generally available in Part B of Form 16.
Step 2: Report It in Schedule Salary, Not Schedule EI
In the ITR forms for FY 2025–26 and AY 2026–27:
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Report the full leave encashment amount as part of gross salary in Schedule S or Schedule Salary.
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Under ‘Allowances to the extent exempt under Section 10,’ select ‘Section 10(10AA) – Earned leave encashment on retirement.’
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Enter only the amount eligible for tax relief.
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The remaining amount will form part of the taxable salary.
For example, if ₹9 lakh was received and ₹7.2 lakh qualifies for relief, report ₹9 lakh as part of salary and claim ₹7.2 lakh under Section 10(10AA). The remaining ₹1.8 lakh will be taxable.
Do not report the relief again in Schedule Exempt Income (EI). The official ITR-2 manual places salary income and exempt allowances in Schedule Salary, while Schedule EI covers items such as exempt interest, dividend, agricultural income, treaty-exempt income and exempt pass-through income.
Step 3: Keep Supporting Documents
Employees should retain:
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Part B of Form 16
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Full-and-final settlement statement
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Leave balance certificate or leave ledger
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Salary slips for the previous 10 months
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Employer’s relief calculation
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Appointment letter or HR confirmation of leave entitlement
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Earlier ITRs in which leave encashment relief was claimed
These documents are not usually submitted with the return, but they may be required if the Income Tax Department asks the employee to support the claim.
Filing-period note: The Section 10(10AA) dropdown and AY 2026–27 reporting instructions above apply to income earned during FY 2025–26 under the Income-tax Act, 1961. For income earned from 1 April 2026, use the field and provision shown in the return applicable to Tax Year 2026–27, as the corresponding rule is now contained in Section 19 of the Income-tax Act, 2025.
Common Mistakes to Avoid
When claiming leave encashment tax relief, employees should avoid these common mistakes:
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Claiming relief during employment: Leave encashment received while still working is fully taxable as salary.
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Assuming ₹25 lakh is automatically tax-free: The actual relief is the lowest of the four prescribed amounts and may be much lower.
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Treating ₹25 lakh as a limit for each employer: It is an overall cumulative limit. Relief claimed earlier must be deducted from the available balance.
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Using the wrong salary amount: The calculation should use the average eligible salary for the 10 months immediately before leaving employment.
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Ignoring the eligible leave limit: Earned leave cannot be counted at more than 30 days for each completed year of service.
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Not keeping supporting records: Employees should retain salary slips, leave records, final settlement documents and details of earlier relief claimed.
These checks can prevent the eligible and taxable amounts from being calculated or reported incorrectly.
How Does Leave Encashment Differ from Other Retirement Benefits?
Leave encashment, gratuity, provident fund and pension may all be received when an employee leaves service, but they are different benefits and follow separate tax rules.
| Benefit | Provision under the Income-tax Act, 1961 | What it covers | Broad tax treatment |
|---|---|---|---|
| Leave encashment | Section 10(10AA) | Payment for unused eligible earned leave | Fully exempt for eligible government employees. For other employees, the lowest-of-four calculation applies, subject to the ₹25 lakh cumulative limit. |
| Gratuity | Section 10(10) | Lump-sum payment recognising an employee’s length of service | Fully exempt for eligible government employees. For other employees, exemption is subject to the applicable formula, actual gratuity received and an overall ₹20 lakh limit |
| Provident fund withdrawal | Sections 10(11) and 10(12) | Withdrawal of accumulated employee and employer contributions with interest | Statutory PF withdrawal is exempt. Recognised PF withdrawal is generally exempt after five years of continuous service or in certain specified situations. |
| Commuted pension | Section 10(10A) | Lump-sum payment received by giving up part of the regular pension | Fully exempt for eligible government, local-authority and statutory-corporation employees. For other employees, one-third is exempt when gratuity is received and one-half when gratuity is not received. |
Frequently Asked Questions
Is Section 10AA the same as Section 10(10AA)?
No. Section 10(10AA) covered tax relief on leave encashment, while Section 10AA dealt with eligible businesses operating in Special Economic Zones. From 1 April 2026, the corresponding leave encashment provisions are covered under Section 19 of the Income-tax Act, 2025.
Is leave encashment received by a legal heir after an employee’s death taxable?
No. Leave encashment received by a legal heir after the employee’s death is fully exempt in the legal heir’s hands. The legal heir does not have to apply the ₹25 lakh limit or the least-of-four calculation.
What are the new rules for leave encashment?
The main change is that the tax-relief limit for non-government employees increased from ₹3 lakh to ₹25 lakh, effective from 1 April 2023. This is a cumulative limit, so earlier claims and amounts received from multiple employers must be counted together. From 1 April 2026, the corresponding rules are covered under Section 19 of the Income-tax Act, 2025, instead of Section 10(10AA) of the earlier Act; the basic calculation and employee categories remain broadly unchanged.
Can leave encashment tax relief be claimed more than once?
Yes. An employee may claim the relief more than once, such as after leaving different employers. However, relief claimed earlier reduces the remaining ₹25 lakh cumulative limit, and the prescribed calculation must be applied each time.
