The leave encashment exemption under Section 10(10AA) of the Income Tax Act, 1961 removes all or part of your retirement leave payout from tax. If you worked for the central or state government, the entire amount is exempt with no upper limit. If you worked for a private employer or a public sector undertaking, the exempt amount is the lowest of four prescribed figures, and your total exemption across your working life cannot exceed ₹25 lakh. The exemption is available under both the old and new tax regimes.
Government Employees Get a Full Exemption
Central and state government employees receive the simplest treatment. Every rupee received as leave encashment at retirement or superannuation is fully exempt from income tax, regardless of the payout size or length of service.1India Code. The Income-Tax Act, 1961 – Section 10(10AA)
Non-government employees — those at private companies and PSUs — qualify too, but only up to a calculated limit. The exempt amount is the lowest of four statutory figures, and the lifetime aggregate cannot exceed ₹25 lakh.2Income Tax Department. Employees – Benefits Allowable Anything above that lowest figure is added to taxable salary for the year.
Only Payouts at Retirement or Resignation Qualify
This is the most common trap. Section 10(10AA) applies only to leave encashment received at retirement, superannuation, or resignation. If your employer pays you for unused leave while you are still working, the entire amount is fully taxable as salary. No part of a mid-service encashment is covered by this exemption.
If a mid-service payout pushes you into a higher bracket, Section 89(1) relief (claimed via Form 10E) can recalculate the liability as though the lump sum had been spread over the years it relates to.3Income Tax Department. Form 10E That is a separate relief; it does not make the income exempt.
The Four-Limit Calculation for Non-Government Employees
Work out all four figures, then keep the smallest one. For assessment year 2026–27, the four are:2Income Tax Department. Employees – Benefits Allowable
- The actual leave encashment paid by your employer.
- The cash equivalent of unutilized earned leave, capped at 30 days per completed year of service with the current employer, multiplied by your average daily salary.
- Ten months’ average salary, calculated over the ten months immediately before retirement.
- ₹25,00,000, reduced by any exemption already claimed from a previous employer.
The 30-day cap overrides your company’s policy. If your employer credits 45 days of earned leave a year, the tax formula still treats it as 30. Twenty years of untaken earned leave gives you 600 days for the calculation, even if HR records show more.
What Counts as Salary Here
The “salary” used in the calculation is narrower than your CTC. It includes only three components:2Income Tax Department. Employees – Benefits Allowable
- Basic pay.
- Dearness allowance, but only the portion that counts toward retirement benefits.
- Commission calculated as a fixed percentage of turnover secured by the employee.
HRA, special allowances, bonuses, and commissions that are not tied to a fixed percentage of turnover are excluded. Pull this breakdown from your final payslips or Form 16 Part B before running the numbers. Using gross salary here is the most frequent source of miscalculated claims, and the mismatch usually surfaces during processing.
The ₹25 Lakh Ceiling Is a Lifetime Limit
The ₹25 lakh cap is not per job. It aggregates across every employer you have ever worked for. The Central Government set the figure through Notification No. 31/2023, effective April 1, 2023.4Press Information Bureau. Increased Limit for Tax Exemption on Leave Encashment for Non-Government Employees
If you claimed ₹8 lakh at a previous exit, only ₹17 lakh of headroom remains for future retirements or resignations. You are responsible for tracking prior claims and disclosing them; the department can cross-check earlier returns and issue a notice if cumulative claims exceed ₹25 lakh. If two employers pay you leave encashment in the same financial year, the combined exemption still cannot cross that ceiling.
A Worked Example
You retire from a private company after 15 years. Your average monthly salary (basic plus DA forming part of retirement benefits) over the last ten months is ₹1,80,000. You have 320 days of unutilized earned leave. Your employer pays ₹19,20,000 as leave encashment. You had claimed ₹2 lakh as exempt at a previous job.
- Actual amount received: ₹19,20,000.
- Cash equivalent of leave: the 30-day cap allows up to 450 days (30 × 15), but you have only 320, so the formula uses 320. Daily salary is ₹1,80,000 ÷ 30 = ₹6,000. So 320 × ₹6,000 = ₹19,20,000.
- Ten months’ average salary: ₹1,80,000 × 10 = ₹18,00,000.
- Statutory cap: ₹25,00,000 − ₹2,00,000 already used = ₹23,00,000.
The lowest figure is ₹18,00,000. That is the exempt amount. The remaining ₹1,20,000 is taxable as salary income for the year.
Reporting It on Your Return
The taxable portion goes under the head “Salaries” on your income tax return. The exempt portion is disclosed separately in the field for allowances exempt under Section 10. Cross-check the figures against your Form 16. If your employer computed a different exempt amount, the mismatch will trigger a query under Section 143(1).
Keep your calculation worksheet, the employer’s computation sheet if you received one, final payslips showing the salary breakdown, and any documentation of prior exemptions from earlier employers. When the Centralized Processing Centre flags a discrepancy, these records are what resolve it. The exemption applies under both the old and new tax regimes, so regime choice does not affect eligibility, though it does affect which other deductions you can pair with it.2Income Tax Department. Employees – Benefits Allowable