Leave Encashment Tax Exemption 2026: Section 10(10AA)’s ₹25 Lakh Lifetime Limit for Private-Sector Employees

By Nitish Bharadwaj · Published Aug 24, 2026 · 6 min

Leave encashment received on resignation, retirement, or superannuation is fully tax-exempt for government employees, but private-sector employees get a capped exemption under Section 10(10AA) — the lowest of four amounts, subject to a ₹25 lakh lifetime ceiling raised from ₹3 lakh by Budget 2023. This guide covers the four-part calculation, why the cap applies across every employer in your career rather than resetting with each job, and confirms the exemption survives under the new tax regime.

Resign from a job with 40 unused days of earned leave, and most employers cash it out in your final settlement rather than letting it carry forward. Retire after three decades of service, and the same thing happens at a much bigger number. For a government employee, that entire payout is fully tax-free. For everyone else — the vast majority of India's salaried workforce — Section 10(10AA) of the Income Tax Act exempts it only up to a point, governed by a four-part formula and a ₹25 lakh lifetime ceiling that most private-sector employees discover only when they're staring at a tax notice.

Government Employees: Fully Exempt, No Cap

Central and state government employees receive complete exemption on leave encashment received at retirement or superannuation, with no rupee ceiling at all. This is the cleanest version of the rule, and the one most leave-encashment explainers focus on — but it applies only to employees of the central government, state governments, and certain statutory bodies. It does not extend to employees of public sector undertakings (PSUs), nationalised banks, or private companies, all of whom fall under the capped rule below.

Private-Sector Employees: The Four-Part 'Lower Of' Formula

For every other employee — private sector, PSU, or otherwise non-government — Section 10(10AA) exempts leave encashment only up to the lowest of four amounts:

1. The actual amount of leave encashment received
2. 10 months' average salary, calculated on the average of the last 10 months before retirement or resignation
3. Cash equivalent of unutilised leave, capped at 30 days for each completed year of service
4. ₹25,00,000 — the statutory ceiling, raised from ₹3,00,000 by Budget 2023, effective for leave encashment received on or after April 1, 2023

Whichever of these four is lowest becomes your exempt amount; anything received above that is added to your salary income and taxed at your slab rate, in the year you receive it.

Yes, the Exemption Survives Under the New Tax Regime

Unlike HRA and LTA — both curtailed for employees who opt into the new tax regime — leave encashment exemption under Section 10(10AA) is not on the list of deductions and exemptions withdrawn under Section 115BAC. You get this exemption whether you file under the old regime or the new one, with no regime-switching trade-off to weigh, which makes it one of the few genuinely regime-neutral benefits still on the books.

Leave Encashed While Still in Service Is Fully Taxable

The exemption above applies only to leave encashed at retirement, superannuation, or resignation — the end of employment. If your employer allows you to encash accumulated leave while you're still working, a common practice at many companies once a year, that payout gets no exemption at all under Section 10(10AA); it's added straight to your salary income and taxed like any other component of your pay, in the year you receive it.

How It Differs From Gratuity

Leave encashment is frequently confused with gratuity because both typically arrive in the same final settlement, but they're governed by entirely separate rules. Gratuity has its own exemption ceiling and its own eligibility condition — five years of continuous service — under a different clause of Section 10, which our gratuity tax exemption guide covers in detail. The two exemptions are independent of each other: using up headroom under one doesn't reduce what's available under the other, and both can apply to the same final settlement simultaneously.

Where to Report It in Your ITR

Leave encashment — both the exempt and taxable portions — is reported under 'Income from Salary' in your ITR, using the exemption break-up your employer typically shows separately in Form 16's Part B. If the exempt amount isn't correctly reflected in Form 16 — common when you've already used up exemption at an earlier employer and the current one isn't aware of it — you can still claim the correct amount at the time of filing, but be ready to show your own computation of the four-part formula, plus evidence of exemption already claimed elsewhere, in case of scrutiny. If you're also dealing with salary arrears from a delayed increment or bonus in the same financial year, our Section 89 relief guide covers how Form 10E softens the tax hit from that bunched-up income.