Calculate Leave Salary or Leave Encashment Earnings 2025 ICAI Exam

Leave Encashment lets employees monetize unused leave days. Easily calculate leave salary and understand tax implications for smarter financial planning.

Leave salary is an important component of employee remuneration, providing workers with equitable compensation for their unused leaves. Most employees, particularly in private organizations, tend to ask questions regarding leave encashment, leave encashment formulas, and the calculation of leave salary. 

This article offers a detailed explanation of how to calculate leave salary, leave encashment on retirement, and different formulas applied in private organizations.

Whether you are an employee attempting to calculate your leave salary or an employer seeking a uniform formula, this tutorial will assist you in comprehending every aspect of encashment of leave.

What is a Leave Encashment?

Leave encashment is the process of crediting the sum of money in return for an employee's unused paid time off. It is known as leave encashment. Workers can save their leaves so they can get paid when they retire or quit their jobs. The employee's complete and final compensation includes leave encashment.

When an employee decides to encash their leave while still working, resigns, or retires, the idea of leave encashment comes into play. 

What are the types of leaves?

The various leaves are listed in the leave policy of an organization. The leave policies vary from organization to organization. Following are the leaves that are commonly available to employees:

  • Casual leave: It's available from 7 to 10 days. These leaves can be used by employees for personal purposes. This leave encashment differs according to the company.
  • Privilege or earned leave: The employee can take earned leaves after giving notice to the management. Leaves are eligible for encashment after a particular duration. The policy is different in different organizations.
  • Medical leaves: If workers are unable to carry out their responsibilities towards the company because of health issues, they should notify the employer about the leaves. The highest number of medical leaves that can be taken varies with different companies.
  • Holiday leaves: Holiday leaves are provided by employees, and no part of the salary is deducted for holiday leaves. The number of holiday leaves varies with every company.
  • Maternity leaves: Maternity leaves are provided to female employees only and can go from 12 weeks to 26 weeks during pregnancy. The employee may request an extension, but no allowance is to be paid for that duration. These leaves are not encashable.
  • Sabbaticals: The employees can avail of leaves for upskilling and enhancing their knowledge. They can take a course, and for that duration, the employer will compensate those leaves.

You must be aware of the many kinds of leaves and which ones are eligible for cash to cash your leaves. The following are some varieties of leaves:

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Leave Type Description Eligibility for Encashment
Casual Leave Commonly used leave with a duration of 7 to 10 days. Must inform employer for encashment. Eligible
Privilege Leave It requires prior notice and varies by organization. Eligible for encashment after a period. Eligibility varies
Medical Leave or Sick Leave For health conditions, it requires employer notice. Eligible for encashment but not long-term. Eligible (Excluding long-term)
Sabbaticals For upskilling, paid and reimbursed by the organization. Eligible for encashment. Eligible
Holiday Leaves Paid leaves, no salary deduction. Eligible for encashment. Eligible
Maternity Leave Available to pregnant employees, varies in duration. Not eligible for encashment. Not eligible
Compensatory Leave / Comp Off Comp off is paid time off given to employees in exchange for working overtime or on holidays. Not eligible
Floater Leave A short period of leave an employee can take on a chosen workday, subject to company approval. Eligibility varies
National Holiday A designated paid day off to commemorate a national event. Not eligible
Marriage Leave Paid leave granted to an employee specifically for getting married. Not eligible
Unpaid Leave A period of leave an employee takes without receiving regular pay. Not eligible

Taxation of Leave Encashment

Leave encashment is a prevalent employee benefit, but its taxation can be tricky. It is important for employers and employees alike to understand the tax implications of leave encashment to ensure compliance. 

  • Leave Encashment During Service: Some organizations allow employees to encash a portion of their leave balance while they are still working. This is common in private companies with flexible HR policies.
  • Leave Encashment on Resignation: When an employee resigns, they may be entitled to encash their accumulated leave balance. The calculation for leave encashment depends on company policies and applicable labor laws.
  • Leave Encashment on Retirement: Employees retiring from service can receive leave encashment based on the accumulated leave balance. Government employees and private sector employees may have different rules regarding this.
  • Leave Encashment for Deceased Employee's Family: If an employee passes away while in service, their legal heirs may receive the leave encashed amount.

Calculation of Leave Salary

The calculation of leave salary depends on several factors, including:

  • Basic salary
  • Dearness Allowance (DA) (if applicable)
  • Number of unused leave days
  • Company policy on leave encashment

Leave Encashment Formula 

Leave encashment is determined using a simple formula, i.e.,

[(Average Basic salary + Average Dearness Allowance) / 30] * No. of Earned Leaves

In the above equation,

  • Average Basic Salary = Average monthly basic salary
  • Average Dearness Allowance = Average monthly dearness allowance (DA)
  • No. of Earned Leaves = Total number of leaves earned

Leave Encashment Calculation (Example)

Let's understand the leave encashment calculation through an example.

Mohan retired from the organization after holding office for a span of 20 years. He was supposed to get 32 days' paid leave for every year. But he consumed 275 leaves and went away with 365 days of leave. He takes home a basic salary + D.A. of INR 30000 monthly at retirement. He got leave encashment of INR 365000 (365*1000).

Description Amount (INR)
Leave encashment amount received 365000 (365*1000)
Exemption under section 10(10AA)
i) Average Salary of 10 months
ii) 30 leaves per year allowed
iii) Maximum Allowed
Lower of all (Exempt Amount)		 300,000
600,000
2,500,000
300,000
Taxable leave encashment (Actual - Exempt) = (365,000-300,000)= 65,000

Thus, INR 65,000 is the taxable leave encashment.

How to Use the Leave Encashment Calculator?

Simplify leave encashment calculations with our intuitive calculator. Learn how to use our Leave Encashment Calculator to accurately determine taxable and exempt amounts, saving time and effort.

Step 1: Choose the employee type as government or non-government, whichever pertains to you.

Step 2: Choose whether you have encashed "During Service" or "At Retirement.

Step 3: Provide the years of service and do not use any fraction for months.

Step 4: Provide your average salary (basic + DA if part of the retirement benefits) for the previous 10 months.

Step 5: Provide the number of unused leaves available for leave encashment

Step 6: Provide the total leaves available throughout the service period per year

Step 7: After entering all the information, it will compute the exemption amount and taxable leave salary.

Is the leave encashment amount taxable? 

An employee's leave encashed is taxable based on when they get it.

Leave encashment during the company: The amount encashed is taxable in full, as it is treated as a component of salary income by the Income Tax Department. This is applicable to both government and private sector employees. Nevertheless, people can claim tax relief under Section 89 of the Income Tax Act.

Leave encashment on death: If the legal heir takes the encashment on the employee's death, the whole amount is exempt from tax.

Leave encashment on retirement or resignation: Encashment made by the Central and state government employees on retirement is exempt from tax. In the case of non-government employees, the encashed value is partially exempt as per the calculation given under Section 10 (10AA)(ii); the remaining amount, if any, is taxable as salary income.

Taxability of Leave Encashment

The tax treatment of leave encashment varies based on employment type.

  1. Government Employees

    • Fully tax-exempt under Section 10(10AA) of the Income Tax Act.

  2. Private Employees

    • Tax exemption limit up to โ‚น25,00,000.

    • Any amount exceeding the limit is taxable under "Income from Salary."

How to Save Tax on Leave Encashment?

  • Plan Leave Usage: Utilize leave instead of encashing to reduce tax liability.
  • Invest in tax-saving instruments Use deductions under Sections 80C, 80D, and others.

Conclusion

Both employers and employees must understand how to compute leave salary. A thorough understanding of leave encashment formulas and tax laws guarantees financial planning and transparency, regardless of whether the leave is encashed during service, upon resignation, or retirement. 

Employees should check company policies, use a leave encashment on a retirement calculator, and plan their leaves wisely to maximize benefits.

FAQs

What is the formula for leave salary contribution?

Leave Salary Contribution = (Pay actually drawn - Pension contribution payable) X Rate of leave salary contribution payable /(100 + Rate of leave salary contribution payable).

How do you calculate annual leave pay?

The employee's daily or hourly rate is multiplied by the number of days or hours of leave taken to determine yearly leave compensation.

How is salary deducted for leave?

To calculate leave deduction from salary, you will have to determine the daily wage of the employee and then deduct the corresponding amount for every day of leave availed, usually called "Loss of Pay" (LOP).

Is salary calculated for 30 days or 22 days?

While certain businesses may utilize a 26-day working basis for some computations, such as leave encashment or gratuity, salary calculations in India normally take into account a 30-day month.

How to calculate the leave salary?

To calculate leave salary, multiply the number of leave days by the employee's daily wage, considering basic salary, dearness allowance, and other eligible components. This calculation determines the leave encashment amount.

What are the rules for leave salary?

In general, leave salary regulations provide that employees on earned leave (or privilege leave) are paid full pay, while those on half-pay leave or leave not due are paid half pay, depending on their pay drawn immediately preceding the leave.

How do you calculate total leave?

To work out total leave, you have to work out your annual leave entitlement (e.g., 20 days or 4 weeks) and then subtract the leave taken, which leaves you with the leave balance.

Is leave salary part of CTC?

No, leave encashment cannot form a component of the CTC. It can, however, be availed of under termination benefits or as an internal component of CTC. It is an amount paid to the employee in lieu of entitled but unutilized leaves. It is a payment for overtime work done by the employee.

How to calculate absent salary?

To compute attendance-based salary, find the worker's daily compensation by dividing her monthly pay by the number of working days of the month, and then subtract the absent-day salary.

What is the 45 days salary rule?

The "45-day salary rule" is the MSME 45-day payment rule, as brought in by the Finance Act 2023, which requires companies to pay their payments to Micro, Small, and Medium Enterprises (MSMEs) within 45 days, or as agreed, and failing which, the deduction of such payments will be allowed only on a payment basis from the profits of the financial year in which the payment is actually made.