How leave encashment is taxed
Leave encashment converts unused earned leave into cash. The arithmetic is simple — a per-day rate multiplied by the days you have accumulated — but the tax treatment depends heavily on whether you are still employed or leaving.
Formula
Encashment = (monthly basic + DA ÷ 30) × number of leave days
- Most employers use a 30-day divisor; some use 26, which produces a higher per-day rate
- Only earned or privilege leave is normally encashable, not casual or sick leave
- Company policy sets the maximum days that can accumulate and be encashed
Tax during service versus at exit
Leave encashed while you are still working is fully taxable as salary, with no exemption. That is the single most common surprise, and it applies even if the payout arrives as a separate credit.
Leave encashed on retirement or resignation is treated differently: for non-government employees an exemption applies, subject to a notified lifetime ceiling that was raised to ₹25 lakh with effect from April 2023. Government employees receive it fully exempt.
How the exemption is actually computed
For non-government employees leaving service, the exemption is the least of four figures: the amount actually received, ten months of average salary, the notified ceiling, and the cash equivalent of leave earned at up to 30 days for each completed year of service less leave already availed or encashed.
The last of those limits is often the binding one, which is why a large accumulated balance does not always translate into a large exempt payout.
Encash now or carry forward?
Carrying leave forward has two advantages: the per-day rate grows with your salary, and encashing at exit may qualify for the exemption instead of full taxation. The risks are policy caps on accumulation and a lapse rule that can quietly delete the balance.
Read the leave policy for the maximum carry-forward and any annual lapse date before deciding to bank leave for years.
What to check on your final settlement
Confirm the leave balance, the per-day divisor used, and whether the calculation applied basic plus DA or a larger salary base. Errors in the divisor alone change the payout by more than 13%.
Also verify how the exemption was applied in your Form 16, since employers occasionally treat exit encashment as fully taxable by default.
Example: 60 days on a ₹50,000 basic
- Monthly basic + DA
- ₹50,000
- Per-day rate (30-day divisor)
- ≈ ₹1,667
- Leave days encashed
- 60
- Gross encashment
- ₹1,00,000
- If encashed during service
- Fully taxable as salary
- If encashed at exit
- Exempt subject to statutory limits
For someone in the 30% bracket, encashing during service leaves about ₹68,800 after tax and cess. The same payout at retirement can be entirely exempt if it falls within the prescribed limits.