Saturday, Dec 09, 2023

Leave Encashment Explained: Rules, Limits, & Taxation

Outlook Money

Leave Encashment Explained: Rules, Limits, & Taxation

Your unused leaves can turn into additional income. Learn about the leave encashment rules, limits, and taxation for the salaried class.

Ever wondered if your unused leaves could bring you extra income? Leave encashment allows employees to receive compensation for their accumulated unutilised leave balance.  

What Is Leave Encashment?  

Leave encashment refers to the compensation provided by an employer to an employee for their unutilized paid leaves at the time of retirement or resignation. According to labor laws, every salaried person is entitled to a minimum number of paid leaves each year. However, it is not mandatory for employees to utilize all their entitled leaves, and many employers offer the option to carry forward these unused leaves to subsequent years.

Employers are required to compensate their employees for the accumulated unused leaves, known as leave encashment. It is important to note that the rules and policies regarding leave encashment may vary from one company to another.

Let's look at the different types of leaves typically available to employees:

Casual Leave: Casual leaves are granted for personal reasons; usually range from 7 to 10 days. The encashment policy for casual leave varies across companies.

Earned Leave Or Privilege Leave: Employees can avail of earned leaves after providing prior notice to the authority. These leaves become eligible for encashment after a specific period, which may vary depending on the organisation's policy.

Medical Leave: When employees are unable to perform their duties due to health conditions, they can take medical leaves. The maximum limit for the number of medical leaves available varies from one company to another.

Holiday Leave: Holiday leaves are granted by employers without any deduction from the salary. The maximum number of holiday leaves permitted may differ from company to company.

Maternity Leave: Maternity leaves are exclusively available for female employees and can range from 12 to 26 weeks during pregnancy. While employees can request extensions, no payment is made for that additional period, and these leaves are not eligible for encashment.

Sabbaticals: Sabbaticals are leaves granted to employees to enhance their skills and knowledge. During this period, employers may reimburse the leaves if employees enroll in a course or pursue upskilling opportunities.

Taxation Of Leave Encashment:

Leave Encashment Received During Service: When an employee receives leave encashment while still employed, the entire amount is considered taxable and forms part of their 'Income from Salary.' However, employees can claim tax benefits under Section 89 of the Income Tax Act. To avail of this relief, they need to fill out Form 10E and submit it online through the income tax portal.

Leave Encashment At The Time Of Retirement Or Resignation: The taxation of leave encashment received at the time of retirement or resignation depends on the employee's category.

State And Central Government Employees: Leave encashment received by government employees is fully tax-exempt.

Non-Government EmployeesFor non-government employees, leave encashment is partly exempt and partly taxable. The exemption calculation follows the guidelines specified in Section 10(10AA)(ii) of the Income Tax Act.

Legal Heir Of A Deceased Employee: Leave encashment received by the legal heir of a deceased employee is fully tax-exempt.

Latest Development

In line with the recent Budget announcement, the tax exemption limit for leave encashment upon retirement has been raised by the finance ministry to Rs 25 lakh for private sector salaried employees. Previously set at Rs 3 lakh since 2002, this increase aims to align with the changing income landscape. The Central Board of Direct Taxes (CBDT) clarified that the total exemption amount under section 10(10AA)(ii) should not exceed Rs 25 lakh when received from multiple employers, applicable from April 1, 2023.

It is essential for employees to understand the rules and limits associated with leave encashment to make informed financial decisions. Additionally, consulting a tax professional or referring to the latest updates in the Income Tax Act can provide accurate information based on individual circumstances.

In conclusion, leave encashment offers employees the opportunity to receive compensation for their unutilized paid leaves. While taxation rules apply to leave encashment received during employment, different exemptions exist for government and non-government employees at the time of retirement or resignation. It is crucial for individuals to stay updated on tax laws and seek professional advice when needed to ensure proper compliance and maximize their financial benefits.