Leave Encashment Tax: The ₹25 Lakh Exemption Explained
Last verified: June 2026, against the Income Tax Act provisions and CBDT rules cited below. Figures apply to FY 2025-26 (AY 2026-27). This is general information, not personal tax advice.
Unused paid leave that your employer pays out in cash — leave encashment — is taxed very differently depending on when you receive it. Take it while still employed and it is fully taxable. Take it when you retire or resign and a large exemption (now up to ₹25 lakh) can shelter most or all of it. Here is how Section 10(10AA) works.
While in service: fully taxable
If you encash leave during employment — say your employer pays out carry-forward leave at year-end — the entire amount is taxable as salary under Section 17(1). No exemption applies.
On retirement or resignation
Here the treatment splits:
- Government employees: leave encashment on retirement is fully exempt.
- Non-government (private) employees: exempt up to a limit under Section 10(10AA).
The ₹25 lakh limit for private employees
For non-government employees, the exemption is the least of these four:
- Actual leave encashment received;
- ₹25,00,000 (the overall lifetime cap, raised from ₹3 lakh effective April 2023);
- 10 months’ average salary (basic + dearness allowance + commission on a fixed percentage of turnover), based on the last 10 months;
- Cash equivalent of unused leave, counted at a maximum of 30 days’ leave per completed year of service.
Whatever exceeds the least of these is taxable as salary. The ₹25 lakh is a lifetime limit across all employers — if you have already used part of it at a previous job, only the balance remains.
It applies under both regimes
The leave-encashment exemption is available whether you are on the old or the new tax regime — you do not need to switch regimes to claim it.
Worked example
A private-sector employee retires and receives ₹18,00,000 as leave encashment. Their 10-month average salary is ₹6,00,000 and the cash equivalent of leave (capped at 30 days/year) works out to ₹16,00,000. The least of {₹18,00,000; ₹25,00,000; ₹6,00,000; ₹16,00,000} is ₹6,00,000 — so ₹6 lakh is exempt and the remaining ₹12 lakh is taxable salary.
How to report it in your ITR
Your employer should show the exempt portion in Form 16 (Form 130 from tax year 2026-27). In the return, the full leave encashment appears in salary, and the exempt amount is claimed under the allowances-exempt section. Check that both employers’ figures add up if you received encashment from more than one job in a lifetime, because the ₹25 lakh limit is cumulative.
Common mistakes
- Treating encashment received while still employed as exempt — it is fully taxable.
- Applying the ₹25 lakh limit per job instead of across your career.
- Ignoring the “10 months’ average salary” and “30 days per year of service” caps, which often produce a lower exempt figure than ₹25 lakh.
Plan the year you leave
If a large taxable portion bunches into one year, Section 89 relief may help where the encashment relates to past years — see Section 89 relief and the layoff money playbook.
What changes under the Income-tax Act, 2025
The Income-tax Act, 2025 replaced the 1961 Act from 1 April 2026. Returns for FY 2025-26 (AY 2026-27) are still filed under the old Act, old section numbers and old forms. From tax year 2026-27 onwards, section numbers and many form numbers change — for example, Form 16 becomes Form 130, Forms 15G/15H merge into Form 121, Form 26QB becomes part of Form 141 and Form 10E becomes Form 39. The underlying rules discussed here were largely carried over; only the references change.
FAQs
Is leave encashment on resignation exempt in the new regime?
Yes, the exemption on retirement or resignation applies under both regimes, within the limits.
Is leave encashment taxed if I take it while still working?
Yes, fully. The exemption applies only on retirement, superannuation or resignation.
Is the ₹25 lakh limit per job?
No. It is a lifetime cap across all employers. Amounts already exempted at earlier jobs reduce what remains.
Are government employees taxed on leave encashment?
No. For government employees, leave encashment on retirement is fully exempt.
Can I claim the exemption under the new regime?
Yes. Section 10(10AA) applies under both the old and new regimes.