Section 10(10AA) covers leave encashment tax exemption- the money an employee receives for unused earned leave. The tax treatment depends on when the amount is received and whether the employee works for the Central or State Government or another organisation.
2026 major update: Section 10(10AA) was part of the Income-tax Act, 1961. From 1 April 2026, the corresponding leave encashment rules are covered under Section 19 of the Income-tax Act, 2025. This article uses the familiar term ‘Section 10(10AA)’ while explaining the rules applicable for Tax Year 2026–27.
Section 10(10AA) at a Glanc...
Section 10(10AA) covers leave encashment tax exemption- the money an employee receives for unused earned leave. The tax treatment depends on when the amount is received and whether the employee works for the Central or State Government or another organisation.
2026 major update: Section 10(10AA) was part of the Income-tax Act, 1961. From 1 April 2026, the corresponding leave encashment rules are covered under Section 19 of the Income-tax Act, 2025. This article uses the familiar term ‘Section 10(10AA)’ while explaining the rules applicable for Tax Year 2026–27.
Section 10(10AA) at a Glance
The tax treatment of leave encashment depends on when the amount is received and whether the employee works for the government or another organisation.
Situation
Tax treatment
Leave encashment received during employment
The full amount is taxable as salary.
Received by a Central or State Government employee on retirement or resignation
The full amount is eligible for tax relief.
Received by any other employee on retirement or resignation
Tax relief is based on the lowest of four prescribed amounts, subject to the remaining ₹25 lakh overall limit.
Received by a legal heir after the employee’s death
The amount is fully exempt in the hands of the legal heir.
What is Leave Encashment?
Leave encashment is the money an employee receives in exchange for unused paid leave. It may be paid while the employee is still working or when they retire, resign or otherwise leave the organisation.
For example, if an employee has 20 unused earned-leave days when leaving the organisation, the employer may convert those days into money based on the applicable salary and company leave policy. The amount paid and the number of leave days that can be encashed depend on the organisation’s leave rules.
How is Leave Encashment Different from Leave Travel Allowance?
Leave encashment pays an employee for unused eligible leave.
Leave Travel Allowance (LTA) is provided towards eligible travel expenses incurred by the employee.
For example, money paid for 20 unused earned-leave days is leave encashment. An allowance provided towards the employee’s personal travel expenses is LTA. The two benefits also follow different tax rules.
Which Types of Leave Can Be Encashed?
Not every type of leave can be converted into money. Encashment depends on the employee’s service rules, applicable labour law and the organisation’s leave policy.
For tax relief under Section 10(10AA), the relevant leave is unused earned leave credited to the employee. The Income Tax Department also describes the benefit as the encashment of unutilised earned leave.
Type of leave
Is it usually encashable?
Treatment
Earned, privilege or annual leave
Yes
Usually carried forward and considered for encashment and related tax relief.
Casual or sick leave
Usually no
May lapse or accumulate, but does not automatically qualify for encashment.
Compensatory leave or comp-off
Policy-based
Can be encashed only if the employer’s rules allow it.
These are statutory or special-purpose leaves and are not normally encashed.
Restricted holidays or leave without pay
No
These do not create an eligible paid-leave balance for encashment.
How Is Leave Encashment Taxed During Employment and After Leaving Service?
Under the earlier Income-tax Act, 1961, Section 192 covered TDS on taxable salary, while Section 10(10AA)(i) and Section 10(10AA)(ii) provided relief on eligible leave encashment received when leaving service.
Leave Encashment Received During Employment
Leave encashment received while an employee is still working is fully taxable as salary. No relief is available under Section 10(10AA) for leave encashed during employment.
For example, if an employee encashes unused leave worth ₹80,000 but continues working for the same employer, the entire ₹80,000 is added to their taxable salary. Under Section 192, the employer includes this amount while estimating the employee’s annual salary income and deducts TDS at the applicable average rate. Section 192 does not provide the exemption; it only governs TDS on the taxable salary amount.
Leave Encashment Received by Central or State Government Employees
Under Section 10(10AA)(i), the entire eligible leave encashment received by an employee of the Central or State Government at retirement, resignation or otherwise leaving service is exempt from tax.
The payment must relate to earned leave available in the employee’s account at the time of leaving service. The ₹25 lakh limit and the prescribed least-of-four calculation do not apply to eligible Central or State Government employees.
What about PSU and public-sector bank employees?
Working for a government-owned organisation does not automatically make someone a Central or State Government employee for this purpose. PSU employees, public-sector bank employees and employees of government-owned companies are generally treated as non-government employees and are subject to the prescribed calculation and ₹25 lakh limit.
Leave Encashment Received by Non-Government Employees
Under Section 10(10AA)(ii), employees other than Central or State Government employees can claim limited relief on leave encashment received at retirement, resignation or otherwise leaving employment.
The eligible amount is the lowest of the actual payment received, ten months’ average salary, the value of eligible unused earned leave and the remaining amount from the ₹25 lakh cumulative limit. Any amount above the eligible relief is taxable as salary and may be considered by the employer while deducting TDS under Section 192.
Commission calculated as a fixed percentage of turnover
Other payments, such as bonus, house rent allowance, overtime pay and variable allowances, are generally not included.
The eligible leave balance is also limited. Earned leave cannot be counted at more than 30 days for each completed year of service with the current employer. Leave already taken or encashed must be deducted from this balance.
Eligible unused leave = Leave earned for completed service − Leave already used or encashed
This calculation is based on service with the employer from whom the employee receives the leave encashment.
Section 10(10AA) Calculation Example
Suppose a non-government employee receives ₹9 lakh as leave encashment after leaving the organisation. Assume that they have not claimed any leave encashment tax relief earlier.
Their details are:
Average monthly salary for the last 10 months: ₹1.2 lakh
Completed years of service: 18 years
Eligible unused earned leave: 180 days or 6 months
Actual leave encashment received: ₹9 lakh
The eligible tax relief will be the lowest of the following:
This taxable amount is added to the employee’s salary income and taxed at the applicable rate.
What Is the Maximum Leave Encashment Tax Relief Limit?
For non-government employees, the maximum monetary limit for leave encashment tax relief is currently ₹25 lakh. This is only one part of the prescribed calculation; the actual relief may be lower depending on the amount received, average salary and eligible unused earned leave.
Why Do Some Sources Mention a ₹3 Lakh Limit?
The earlier tax-relief limit for non-government employees was ₹3 lakh. Notification No. 31/2023 increased it to ₹25 lakh with effect from 1 April 2023.
The notification was issued on 24 May 2023, but the revised limit applies retrospectively from 1 April 2023. The change applies to non-government employees; eligible Central and State Government employees continue to receive full tax relief without this monetary ceiling.
Is the ₹25 Lakh Limit Available for Every Employer?
No. The ₹25 lakh amount is a cumulative limit, not a separate limit for each employer or each employment. Relief claimed in earlier years must be deducted from the available limit, and payments received from multiple employers must be considered together.
For example, if an employee has already claimed ₹6 lakh as tax relief in the past, the remaining limit will be:
₹25 lakh − ₹6 lakh = ₹19 lakh
However, ₹19 lakh does not automatically become tax-free. The employee must still apply the lowest-of-four calculation, and the actual relief may be lower.
Important: Changing employers does not reset the ₹25 lakh limit. Employees should keep records of any leave encashment tax relief claimed earlier.
Is Leave Encashment Tax Relief Available Under Both Tax Regimes?
Yes. Leave encashment tax relief is available under both the old and new tax regimes. The ₹25 lakh ceiling, the lowest-of-four calculation and the distinction between government and non-government employees remain the same in both regimes.
What changes is the tax treatment of the taxable portion, if any. Under the old regime, an employee may be able to reduce total taxable income further by claiming deductions such as Section 80C, Section 80D and HRA, where applicable. Under the new regime, many of these deductions are not available, so the final tax outgo may differ even though the leave encashment exemption itself remains the same.
How to Claim and Document Leave Encashment Tax Relief?
Leave encashment received when leaving employment must be reported as part of salary income. The full amount and the eligible tax relief are shown separately so that only the remaining balance becomes taxable.
Step 1: Verify the Amount in Form 16
Check Part B of Form 16 and your full-and-final settlement statement. The employer should report the complete leave encashment amount as part of salary and show the eligible relief separately under allowances exempt under Section 10.
If the figures are missing or incorrect, compare them with your salary slips, leave records and the calculation provided by your employer. Information about salary allowances and their exempt portions is generally available in Part B of Form 16.
Step 2: Report It in Schedule Salary, Not Schedule EI
In the ITR forms for FY 2025–26 and AY 2026–27:
Report the full leave encashment amount as part of gross salary in Schedule S or Schedule Salary.
Under ‘Allowances to the extent exempt under Section 10,’ select ‘Section 10(10AA) – Earned leave encashment on retirement.’
Enter only the amount eligible for tax relief.
The remaining amount will form part of the taxable salary.
For example, if ₹9 lakh was received and ₹7.2 lakh qualifies for relief, report ₹9 lakh as part of salary and claim ₹7.2 lakh under Section 10(10AA). The remaining ₹1.8 lakh will be taxable.
Do not report the relief again in Schedule Exempt Income (EI). The official ITR-2 manual places salary income and exempt allowances in Schedule Salary, while Schedule EI covers items such as exempt interest, dividend, agricultural income, treaty-exempt income and exempt pass-through income.
Appointment letter or HR confirmation of leave entitlement
Earlier ITRs in which leave encashment relief was claimed
These documents are not usually submitted with the return, but they may be required if the Income Tax Department asks the employee to support the claim.
Filing-period note: The Section 10(10AA) dropdown and AY 2026–27 reporting instructions above apply to income earned during FY 2025–26 under the Income-tax Act, 1961. For income earned from 1 April 2026, use the field and provision shown in the return applicable to Tax Year 2026–27, as the corresponding rule is now contained in Section 19 of the Income-tax Act, 2025.
Common Mistakes to Avoid
When claiming leave encashment tax relief, employees should avoid these common mistakes:
Claiming relief during employment: Leave encashment received while still working is fully taxable as salary.
Assuming ₹25 lakh is automatically tax-free: The actual relief is the lowest of the four prescribed amounts and may be much lower.
Treating ₹25 lakh as a limit for each employer: It is an overall cumulative limit. Relief claimed earlier must be deducted from the available balance.
Using the wrong salary amount: The calculation should use the average eligible salary for the 10 months immediately before leaving employment.
Ignoring the eligible leave limit: Earned leave cannot be counted at more than 30 days for each completed year of service.
Not keeping supporting records: Employees should retain salary slips, leave records, final settlement documents and details of earlier relief claimed.
These checks can prevent the eligible and taxable amounts from being calculated or reported incorrectly.
How Does Leave Encashment Differ from Other Retirement Benefits?
Leave encashment, gratuity, provident fund and pension may all be received when an employee leaves service, but they are different benefits and follow separate tax rules.
Benefit
Provision under the Income-tax Act, 1961
What it covers
Broad tax treatment
Leave encashment
Section 10(10AA)
Payment for unused eligible earned leave
Fully exempt for eligible government employees. For other employees, the lowest-of-four calculation applies, subject to the ₹25 lakh cumulative limit.
Gratuity
Section 10(10)
Lump-sum payment recognising an employee’s length of service
Fully exempt for eligible government employees. For other employees, exemption is subject to the applicable formula, actual gratuity received and an overall ₹20 lakh limit
Provident fund withdrawal
Sections 10(11) and 10(12)
Withdrawal of accumulated employee and employer contributions with interest
Statutory PF withdrawal is exempt. Recognised PF withdrawal is generally exempt after five years of continuous service or in certain specified situations.
Commuted pension
Section 10(10A)
Lump-sum payment received by giving up part of the regular pension
Fully exempt for eligible government, local-authority and statutory-corporation employees. For other employees, one-third is exempt when gratuity is received and one-half when gratuity is not received.
Frequently Asked Questions
Is Section 10AA the same as Section 10(10AA)?
No. Section 10(10AA) covered tax relief on leave encashment, while Section 10AA dealt with eligible businesses operating in Special Economic Zones. From 1 April 2026, the corresponding leave encashment provisions are covered under Section 19 of the Income-tax Act, 2025.
Is leave encashment received by a legal heir after an employee’s death taxable?
No. Leave encashment received by a legal heir after the employee’s death is fully exempt in the legal heir’s hands. The legal heir does not have to apply the ₹25 lakh limit or the least-of-four calculation.
What are the new rules for leave encashment?
The main change is that the tax-relief limit for non-government employees increased from ₹3 lakh to ₹25 lakh, effective from 1 April 2023. This is a cumulative limit, so earlier claims and amounts received from multiple employers must be counted together. From 1 April 2026, the corresponding rules are covered under Section 19 of the Income-tax Act, 2025, instead of Section 10(10AA) of the earlier Act; the basic calculation and employee categories remain broadly unchanged.
Can leave encashment tax relief be claimed more than once?
Yes. An employee may claim the relief more than once, such as after leaving different employers. However, relief claimed earlier reduces the remaining ₹25 lakh cumulative limit, and the prescribed calculation must be applied each time.
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