Leave Encashment Tax Exemption: Section 10 (10AA), Rs 25 Lakh

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:

1. The overall monetary limit notified by the Central Government, currently Rs 25,00,000.
2. The actual leave encashment amount received from the employer.
3. 10 months average salary, that is, the average monthly salary of the last 10 months immediately before retirement, multiplied by 10.
4. The cash equivalent of unutilised earned leave, where leave is capped at 30 days for each completed year of service (reduced by any earned leave already availed), valued at the average monthly salary.

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:

1. Statutory limit: Rs 25,00,000.
2. Actual amount received: Rs 8,40,000.
3. 10 months average salary: Rs 80,000 x 10 = Rs 8,00,000.
4. Cash equivalent of leave: her 30-days-per-year cap is 28 x 30 = 840 days, which is more than her 300 unutilised days, so 300 days count. 300 days is 10 months (300 / 30), valued at Rs 80,000 = Rs 8,00,000.

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.

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:

• Basic salary, plus
• Dearness allowance, to the extent it forms part of retirement benefits, plus
• Commission received as a fixed percentage of turnover achieved by the employee.

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.

1. Obtain Form 16 from your employer; the leave encashment figure appears under salary.
2. Compute the four amounts and identify the least, that is your exempt figure.
3. In the ITR salary schedule, report gross salary, then claim the exempt portion under the Section 10(10AA) dropdown (“Cash equivalent of leave salary encashment”).
4. The taxable balance, if any, stays inside taxable salary and is taxed at slab rate.
5. If you encashed leave during service and your income spiked, file Form 10E before filing your return to claim Section 89 relief.

• Assuming the full Rs 25 lakh is yours. The cap is only one of four figures; the least usually wins, often the 10-months average (Section 10(10AA)(ii)).
• Treating a PSU or bank job as a government job. PSU and nationalised-bank staff are non-government for Section 10(10AA), so the cap applies.
• Claiming exemption on encashment taken during service. That is fully taxable; only Section 89 relief via Form 10E may soften it.
• Forgetting the lifetime nature of the cap. The Rs 25,00,000 is reduced by exemption already claimed in earlier years or from another employer.
• Counting more than 30 days of leave per completed year. The cash-equivalent leg caps creditable leave at 30 days for each completed year of service.

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.

• Income-tax Act 1961, Section 10(10AA) - leave encashment exemption.
• CBDT Notification No. 31/2023, F.No. 200/3/2023-ITA-I, dated 24 May 2023, specifying Rs 25,00,000 as the limit under Section 10(10AA)(ii), effective 1 April 2023.
• Press Information Bureau release on the increased leave encashment exemption for non-government salaried employees.
• ClearTax, “Leave Encashment - Tax Exemption, Calculation and Formula”: https://cleartax.in/s/leave-encashment-tax

• HRA exemption under Section 10(13A)
• Section 80CCD(1B): extra Rs 50,000 NPS deduction
• The RTI Act 2005, full text
• Draft an RTI application online
• The RTI Playbook