MC Explains: Higher tax exemption on leave encashment for non-govt employees

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India’s central government on May 24 raised the limit for tax exemption on leave encashment for non-government salaried employees. The move, first proposed in the union budget for 2023-24 presented on February 1, was notified in the gazette, making it effective from April 1, 2023.

Moneycontrol explains what the move means for employees:

What was the norm till now?

Non-government salaried employees, or simply put, salaried employees in private companies, used to enjoy a tax exemption on leave encashment of up to Rs 3 lakh.

This meant, at retirement or on leaving a job, the employee did not need to pay tax on leave encashment of up to Rs 3 lakh.

This Rs 3 lakh limit was last fixed in 2002, when the highest basic pay in the government was Rs 30,000 per month, Finance Minister Nirmala Sitharaman had said in her budget speech.

Non-government employees who receive leave encashment over the Rs 3 lakh limit had to pay tax on the same.

Often, the leave encashment could be higher as leave balances could be accumulated over several years.

What has changed?

As per the gazette notification, the tax exemption on leave encashment for non-government employees has been raised eightfold, to Rs 25 lakh, from April 1, 2023.

This enhanced leave encashment limit will apply even in cases where a person has quit two jobs in the same year, according to a government statement.

How to claim tax exemption on leave encashment?

Leave encashment is taxable as income from salary at the time of retirement or switching of jobs. However, employees can claim exemption for the same under Section 10 of the Income Tax Act.

Chances are that if you retired prior to May 24, 2023, the employer would have assumed the tax-free limit to be Rs 3 lakh and deducted tax accordingly. You can revert to the employer and request for the deduction to be revised per the extant norms.

Do note, several companies do not allow leave encashment at all. Employees at such firms remain unaffected by the change in this income tax rule.

What about government employees?

In the case of central or state government employees, any amount received for encashment of accumulated leave at the time of retirement is exempt from tax, according to the Income Tax Department.