Quick answer: Leave encashment at retirement is governed by Section 10(10AA) of the Income-tax Act 1961. For Central and State Government employees it is fully exempt. For private and PSU employees it is exempt up to the least of four amounts, with an overall cap of Rs 25,00,000 (raised from Rs 3 lakh with effect from 1 April 2023). Encashment taken during service is fully taxable.
If your employer paid you for unused earned leave when you retired, the first question is simple: how much of it can you keep tax-free? The answer depends on one thing above all else, whether you worked for the government or for a private or public-sector employer. This guide gives you the exact rule, the four-figure calculation, and a worked example with real numbers.
For a non-government employee, the exempt portion of leave encashment received at retirement or resignation is the lowest of these four figures:
Whatever amount is left after subtracting the exempt portion from what you actually received is added to your salary income and taxed at your slab rate. The Rs 25,00,000 is a lifetime ceiling: it is reduced by any Section 10(10AA) exemption you have already claimed in earlier years or from another employer.
Meera Iyer retires from a private bank in Pune on 31 March 2026 after 28 completed years of service. Her average monthly salary (basic salary plus dearness allowance that forms part of retirement benefits) over her last 10 months is Rs 80,000. She had 300 days of unutilised earned leave, and the bank paid her Rs 8,40,000 as leave encashment.
The four amounts are:
The least of these is Rs 8,00,000. So Rs 8,00,000 is exempt, and the balance, Rs 8,40,000 minus Rs 8,00,000 = Rs 40,000, is taxable as salary in FY 2025-26.
Notice that the Rs 25 lakh cap did not bind at all. For most private employees it is the 10 months average salary leg that is the real ceiling, which is why many cannot shelter the full Rs 25 lakh.
| Type of employer | Tax on leave encashment at retirement |
|---|---|
| Central Government | Fully exempt under Section 10(10AA)(i). |
| State Government | Fully exempt under Section 10(10AA)(i). |
| Private sector / PSU / nationalised bank / autonomous body | Exempt only up to the least of the four amounts above, capped at Rs 25,00,000. |
| Any employee, encashment taken during service | Fully taxable. Relief under Section 89 may be claimed via Form 10E. |
Employees of public-sector undertakings and nationalised banks are treated as non-government for this purpose, not as government servants, so they fall under the Rs 25 lakh four-part rule, not the full exemption.
For the 10-months-average and cash-equivalent legs, “salary” means:
House rent allowance, overtime, bonus, and other allowances are not included.
For two decades the cap for non-government employees was stuck at Rs 3,00,000, a figure notified back in 2002. The Finance Minister announced an increase in the 2023 Budget, and the Central Board of Direct Taxes gave it effect through Notification No. 31/2023 dated 24 May 2023, raising the ceiling to Rs 25,00,000 with effect from 1 April 2023. The new limit applies to non-government employees retiring on or after that date.
At retirement it is partly or fully exempt under Section 10(10AA): fully for government employees, and up to the least of four amounts (cap Rs 25,00,000) for others. Leave encashment taken during service is fully taxable.
The overall cap is Rs 25,00,000, raised from Rs 3,00,000 with effect from 1 April 2023. The actual exempt amount is the least of four figures, so it is often lower than Rs 25 lakh.
Yes. Central and State Government employees receive a full exemption on leave encashment at retirement under Section 10(10AA)(i), with no monetary cap.
No. Employees of public-sector undertakings, nationalised banks, and autonomous bodies are non-government for Section 10(10AA), so the Rs 25 lakh four-part rule applies to them.
It is the maximum leave encashment exemption for non-government employees, notified by CBDT in Notification No. 31/2023 dated 24 May 2023, effective 1 April 2023.
Basic salary, dearness allowance to the extent it forms part of retirement benefits, and commission as a fixed percentage of turnover. Other allowances like HRA and bonus are excluded.
It is a lifetime aggregate. The Rs 25,00,000 ceiling is reduced by any Section 10(10AA) exemption you have already claimed in earlier years or from another employer.
Encashment during service is fully taxable, but you can claim relief under Section 89 by filing Form 10E on the income-tax portal before submitting your return.