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A Quick Guide On Leave Encashment

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Created on
January 9, 2023


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Are you one of those employees who never take any of their paid leaves unless absolutely necessary?

If you answered yes to that, you might have a ton of leave encashment benefits waiting for you! But to utilize these benefits to the fullest, you need to understand what they are, how they work, and how they are taxed. 

Let’s delve into these details. 

What is Leave Encashment?

Leave encashment is the process of encashing unused paid leaves in exchange for monetary compensation. Generally, most employers allow you to opt for this feature as part of the full and final settlement process initiated at the time of retirement, termination, or resignation. 

However, there are certain employers who also allow you to encash your leaves even while you’re in active service. In this case, the leave encashment feature would only be available to you once a year. 

Depending on the organisation, the leave encashment policy may vary. 

Types of Leaves Available to Employees

Now that you’re aware of the meaning of leave encashment, let’s look at the different kinds of leaves that are generally available to the employees of an organisation. 

Casual Leaves

Casual leaves are one of the most common types of leaves available to employees. An employee may make use of this leave for personal reasons. Depending on the organisation’s policy, around 7 to 10 casual leaves per year are offered. 

However, a few employers offer even 12 casual leaves, one for each month of a year. Also, based on the company’s leave encashment policy, casual leaves may or may not be eligible for leave encashment. 

Privilege Leaves

Privilege leaves are the ones that can be availed by an employee by providing their employer with adequate prior intimation. Unused privilege leaves usually become eligible for leave encashment after a certain period of time has elapsed. 

As with casual leaves, the organisation’s encashment policy dictates when privilege leaves become eligible for encashment. 

Medical Leaves

As the name suggests, medical leaves are ones that are availed by an employee on account of them suffering from health-related issues. The number of medical leaves available for encashment is usually dictated by the leave encashment policy of the organisation. 

Maternity Leaves

Employers often provide pregnant employees extended leaves, known as maternity leaves. Usually, organisations provide anywhere from 12 to 26 weeks of maternity leaves to their pregnant women employees with scope for extension of the same. Such kinds of leaves are not considered for leave encashment. 

Taxation on Leave Encashment

The taxation on leave encashment is primarily dependent on whether you opt for it during your service or at the time of retirement, termination, or resignation. We’re going to take a look at different scenarios to understand how the encashment of earned leaves is taxed. Let’s begin. 

1. Leave encashment received during service

If you opt to encash your leaves whilst you’re still in active service, the money you receive against them will be considered as ‘salary income’ and will be fully taxable. The applicable tax rate will depend on the income tax slab you fall under. However, you can claim relief under section 89(1) of the Income Tax Act, 1961.

2. Leave encashment at retirement or resignation

The taxability of leave encashment that you receive at the time of retirement, resignation, or termination may vary depending on the status of your employment; it can either be fully exempt or partially exempt from tax. Here’s a slightly more in-depth overview.

3. Leave encashment by central or state govt employees

In the case of employees working in a central or state government organisation, encashment of earned leaves is fully exempt from tax. 

  • Leave encashment received by the legal heirs of deceased employees 

Similarly, leave encashment amounts received by legal heirs of deceased employees are also fully exempt from tax. 

  • Leave encashment received by non-government employees

In the case of a non-government employee, the encashment of earned leaves is only partially taxable. Here’s an example that can help you understand just how the taxable portion of leave encashment for non-government employees is arrived at. 

Assume that you’re a non-government employee who just retired after serving for about 20 continuous years. According to your organisation’s leave policy, you were entitled to 25 days of paid leaves per year. This would leave you with 500 days of paid leaves (25 days per year x 20 years) throughout the entire tenure of your service. 

Out of the 500 paid leaves, let’s say that you’ve used up 80 leaves. This leaves you with 420 (500 - 80) unused paid leaves. Per the company’s records, your last drawn monthly salary was ₹52,000, including basic pay and Dearness Allowance (DA). Now, using these figures, we can arrive at the amount of leave encashment that’s actually taxable on your hands.

As you can see, out of the total amount that you received as leave encashment, only a part of it is taxable, which is ₹4,27,860. This amount will be accounted as ‘salary income’ and the rate at which it is taxed will depend on the income tax slab rate applicable to you.  


The article should give you a better idea of what leave encashment is, how it is calculated and how it is taxed. And if you have a chunk of unutilised paid leaves, you now know how they can be monetised via the encashment of earned leave.

Frequently Asked Questions

1. When can leave encashment be paid?

Leave encashment can be paid to an employee either when they are employed in an organisation, or at the time of retirement or resignation. In case the leave encashment is paid during service, you can claim relief under section 89 of the Income Tax Act, 1961. 


Fi Money is not a bank; it offers banking services through licensed partners and investment services through epiFi Wealth Pvt. Ltd. and its partners. This post is for information only and is not professional financial advice.
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