Understanding Tax Exemption on Leave Encashment for Employees at Retirement
The income-tax rules provide tax exemption on leave encashment or leave salary for salaried employees at the time of retirement, including those in the private sector, up to a certain limit. This article outlines how tax exemption on leave encashment is calculated, particularly for employees who have received leave encashment from two different employers. This might occur in the financial year 2024-25 (Assessment Year 2025-26) or from one employer in the current fiscal year and another in any previous fiscal year.
Tax Rules on Leave Encashment
As per a notification dated May 24, 2023, the Central Board of Direct Taxes (CBDT) has raised the tax exemption limit on leave encashment to ₹25 lakh for non-government employees. However, it’s important to note that there are certain conditions tied to this exemption limit.
According to a CBDT circular dated February 20, 2025, a non-government employee can avail of tax exemption on leave encashment upon retirement. The exemption amount that can be claimed will be the lower of the following:
- Period of earned leave standing to the credit in the employee’s account at retirement multiplied by the average monthly salary.
- Average monthly salary multiplied by 10, which equates to 10 months’ average salary.
- Maximum amount specified by the central government, currently ₹25,00,000.
- Actual leave encashment received at the time of retirement.
Leave Encashment from Multiple Employers
What happens if an employee receives leave encashment from two employers? The maximum exemption amount cannot exceed the ₹25 lakh limit if an employee has received leave encashment from two employers within the same financial year.
If an employee availed of leave encashment exemption from a previous employer in an earlier financial year, the ₹25 lakh ceiling will be reduced by the amount previously claimed when seeking tax exemption against leave salary from the current employer.
According to the CBDT circular, “If an employee receives leave salary from more than one employer in the same year, then the maximum amount of exemption under section 10(10AA)(ii) of the Income-Tax Act, 1961 cannot exceed the amount specified by the Central Government (i.e., ₹25,00,000).” Furthermore, “Where any employee has claimed exemption of leave salary under this section in any earlier year(s), then in case of such employee, the ceiling limit (i.e., ₹25,00,000) shall be reduced by the amount of exemption earlier claimed.”
Conclusion
Employees need to be aware of the tax exemption limits and rules related to leave encashment upon their retirement. Understanding how to calculate the exemption, especially when receiving leave encashment from multiple employers, will ensure that employees can effectively navigate the tax implications and maximize their benefits. It’s advisable to consult with a tax professional for personalized guidance to make the most informed decisions regarding leave encashment and tax exemption.