ITR Filing AY 2026-27: Tax Treatment of Leave Encashment for Salaried Employees

Salaried taxpayers may be eligible to claim a tax exemption on leave encashment received at the time of retirement, subject to the provisions of the Income Tax Act. While government employees are entitled to a complete exemption on the leave encashment amount received upon retirement, employees working in the private sector and public sector undertakings (PSUs) can avail exemption up to ₹25 lakh, subject to prescribed conditions and calculation methods based on salary and accumulated earned leave. The exempt and taxable portions of leave encashment are reported under the head "Income from Salary" while filing the Income Tax Return (ITR).

As a general rule, leave encashment received during the course of employment is fully taxable as salary income, irrespective of whether the employee works in the government or private sector. However, a different tax treatment applies when the amount is received on retirement, resignation, or superannuation. In such cases, non-government employees can claim exemption only up to the limit specified under the Income Tax Act, and any amount exceeding the eligible exemption becomes taxable.

For Central and State Government employees, the tax provisions are more favorable. Under Section 10(10AA)(i) of the Income Tax Act, the entire amount of leave encashment received at retirement is exempt from income tax without any monetary ceiling.

Additionally, some organizations permit employees to avail leave in advance for exceptional circumstances such as medical emergencies or personal contingencies. If an employee has already utilized more leave than he or she has accrued, there may be little or no earned leave balance available for encashment at retirement. In such situations, the employee may not qualify for the leave encashment exemption, and the amount received could be treated as fully taxable salary income.