Leave encashment is the money you get for unused earned leave, either at the end of a year or when you resign or retire. Since 21 November 2025 the leave rules for workers come from the OSH Code, 2020, the pay is worked out on wages under the Code on Wages, and from 1 April 2026 the tax relief is in Section 19 of the Income-tax Act, 2025. This guide explains the leave encashment rules, the calculation and the tax, with five worked examples.
Quick answer: leave encashed during service is fully taxable. On resignation or retirement, government employees pay no tax on it, and private employees get tax relief up to the least of four limits, including a ₹25 lakh lifetime cap. To work out your own figure, use our leave encashment calculator.
Which Leave Can Be Encashed?
| Leave type | Usually encashable? |
|---|---|
| Earned leave / privilege leave / annual leave | Yes, under law and most policies |
| Casual leave | Usually no; lapses at year-end unless your policy says otherwise |
| Sick leave | Usually no; some employers allow it by policy |
| Maternity, paternity, bereavement leave | No |
The legal right is to encash earned (annual) leave. Any wider encashment comes from your company's leave policy or your state's Shops and Establishments Act.
Leave Encashment Rules Under the OSH Code 2020
The main leave encashment rules for workers covered by the Occupational Safety, Health and Working Conditions Code, 2020 are in Section 32:
- Earning leave: 1 day of leave for every 20 days of work, once you have worked 180 days in a calendar year.
- Carry forward: up to 30 days into the next year. Leave you asked for and were refused is not lost.
- Year-end encashment: a worker may ask to encash leave at the end of the calendar year.
- On leaving: unused leave must be paid within 2 working days of resignation, discharge or dismissal, and within 2 months of retirement or death.
- Better terms in a state law, contract or company policy still apply.
Read our guide to the OSH Code 2020 and the Ministry of Labour and Employment for the Code and rules. Central government employees follow their own leave rules instead, which allow up to 300 days of earned leave to be encashed on retirement.
How to Calculate Leave Encashment
The leave encashment formula needs three things: your wages, a daily divisor and your unused leave days.
- Find your monthly wages. Under the Code on Wages, wages are Basic + DA + retaining allowance; if your other allowances are more than 50% of total pay, the extra is added back. It is not your gross salary or CTC. See the Code on Wages 50% rule.
- Find your daily wage: monthly wages ÷ 26 (common, as weekly offs are already paid) or ÷ 30, as your leave policy says.
- Multiply by unused leave days.
| Monthly wages ₹40,000, 30 days of leave | ÷ 26 days | ÷ 30 days |
|---|---|---|
| Daily wage | ₹1,538.46 | ₹1,333.33 |
| Leave encashment | ₹46,154 | ₹40,000 |
The divisor alone changes the payout by about 15%, so check your policy.
Is Leave Encashment Taxable?
| When paid | Government employee | Private / PSU employee |
|---|---|---|
| During service (year-end encashment) | Fully taxable | Fully taxable |
| On retirement or resignation | Fully exempt | Exempt up to the least of four limits |
| To legal heirs after death in service | Not taxable | Not taxable |
From tax year 2026-27 the exemption is in Section 19 of the Income-tax Act, 2025 (earlier Section 10(10AA) of the 1961 Act). It is available in both the old and the new tax regime. Payments to legal heirs are not taxed as salary, as clarified in CBDT Circular No. 309 of 1981.
Leave encashment tax exemption: four limits for private employees
The tax-free amount on resignation or retirement is the least of:
- The leave encashment actually received.
- 10 × average monthly salary of the last 10 months.
- Cash value of leave to your credit, counting at most 30 days for every completed year of service, at average salary ÷ 30 per day.
- ₹25,00,000, a lifetime limit across all employers (raised from ₹3 lakh from 1 April 2023 by CBDT Notification 31/2023), minus any exemption you claimed earlier.
"Salary" for this test is Basic + DA (DA only if it counts for retirement benefits) + commission at a fixed percentage of turnover. Resignation counts as retirement for this purpose, as held by the Bombay High Court in CIT v. D.P. Malhotra (1997). The rest is taxed as salary; your employer deducts TDS on it. The Act is on the Income Tax Department website.
Leave Encashment Calculation Examples
Example 1: Resignation from a private company
Monthly wages and average Basic + DA ₹40,000, 45 days of leave, 6 completed years, policy divides by 26.
- Leave encashment received: ₹40,000 ÷ 26 × 45 = ₹69,231
- Limit 2: 10 × ₹40,000 = ₹4,00,000
- Limit 3: 45 days (below 6 × 30 = 180) × ₹40,000 ÷ 30 = ₹60,000
- Limit 4: ₹25,00,000
Tax-free = ₹60,000; taxable = ₹9,231. The taxable part arises only because the payout uses ÷ 26 while the tax rule values leave at ÷ 30.
Example 2: Retirement after 25 years, private sector
Average Basic + DA ₹1,00,000 a month, 300 days of leave, 25 completed years, ÷ 26 policy.
| Limit | Amount |
|---|---|
| 1. Actual encashment (₹1,00,000 ÷ 26 × 300) | ₹11,53,846 |
| 2. 10 × average salary | ₹10,00,000 |
| 3. 300 days × ₹1,00,000 ÷ 30 | ₹10,00,000 |
| 4. Lifetime limit | ₹25,00,000 |
| Tax-free (least) | ₹10,00,000 |
| Taxable | ₹1,53,846 |
Example 3: Government employee retiring with 300 days
Basic + DA ₹80,000, 300 days of earned leave, at ₹80,000 ÷ 30 a day = ₹8,00,000, fully tax-free because the employee is a central or state government employee.
Example 4: Year-end encashment while in service
Wages ₹30,000, 12 days encashed in December at ÷ 26: ₹30,000 ÷ 26 × 12 = ₹13,846. This is added to salary and taxed at your slab rate in your chosen regime.
Example 5: Second retirement, lifetime limit already used
A private employee claimed ₹20,00,000 exemption on leaving an earlier employer. On retiring now, the four limits come to ₹8,00,000, but the lifetime limit left is only ₹25,00,000 − ₹20,00,000 = ₹5,00,000. So ₹5,00,000 is tax-free and the remaining ₹3,00,000 is taxable.
Leave Encashment in Full and Final Settlement
When you resign, leave encashment is one line of your full and final settlement, along with pending salary, bonus and gratuity if you have 5 or more years of service. Check that it uses your wages (not just Basic), the right leave balance and your policy's divisor.
Common Mistakes
- Using the old ₹3 lakh exemption limit. It has been ₹25 lakh since 1 April 2023.
- Treating ₹25 lakh as the only test. The exemption is the least of four limits.
- Calculating on gross salary or CTC. Use wages for the payout and Basic + DA for the tax test.
- Expecting tax relief on year-end encashment during service. It is fully taxable.
- Assuming casual and sick leave are encashable. Only earned leave is, unless your policy says more.
Check your figures with our leave encashment calculator, and see the tax effect with the income tax calculator.
Frequently Asked Questions
How is leave encashment calculated?
Divide your monthly wages by 26 (or 30, if your policy says so) and multiply by your unused leave days. For ₹40,000 wages and 30 days: ₹40,000 ÷ 26 × 30 = ₹46,154.
Is leave encashment calculated on basic or gross salary?
Under the labour codes it is calculated on wages: Basic + DA + retaining allowance, plus any allowances above 50% of total pay. It is not calculated on full gross salary or CTC.
Is leave encashment taxable?
During service, fully. On retirement or resignation, government employees are fully exempt and private employees are exempt up to the least of four limits, including ₹25 lakh, under Section 19 of the Income-tax Act, 2025.
How much leave encashment is tax-free for private employees?
The least of: the amount received, 10 months' average salary, leave value at 30 days per completed year of service, and ₹25 lakh minus any exemption claimed earlier.
Is leave encashment on resignation tax-free?
Yes, within the same four limits. Resignation is treated as retirement for this exemption, as the Bombay High Court held in CIT v. D.P. Malhotra (1997).
Is the leave encashment exemption available in the new tax regime?
Yes. The exemption on retirement or resignation is allowed in both the old and the new tax regime.
How do I calculate 300 days leave encashment?
Multiply the daily rate by 300. For government employees it is usually (Basic + DA) ÷ 30 × 300, so ₹80,000 Basic + DA gives ₹8,00,000, fully tax-free on retirement.
Should leave encashment be calculated on 26 or 30 days?
Follow your company's leave policy. Dividing by 26 gives a higher daily rate than 30. The tax exemption test always values leave at average salary ÷ 30.
Can I encash leave while still working?
Yes. The OSH Code lets a worker ask to encash leave at the end of the calendar year, and many policies allow it. This encashment is fully taxable.
Is leave encashment paid to legal heirs taxable?
No. Leave salary paid to the legal heirs of an employee who dies in service is not taxable as salary, as clarified in CBDT Circular No. 309 dated 3 July 1981.