How to calculate Tax exemption on Leave Encashment?

When an employee is retiring or is relieved from an organization, if they have a leave balance in any of their Paid leaves, we pay them the Leave encashment as compensation for their unavailable leave balance. This Leave encashment is auto-calculated in Keka while processing the full and final settlement.

Tax exemption on Leave encashment is the least of the following four values:

1) Leave Encashment salary Received: This is the amount the employee is being paid as Leave Encashment

2) 10 months' total Salary: Total Salary in this scenario is Basic+DA+Percentage Commission (If any). We take the total BASIC and DA amount paid to the employee in the last 10 months of his employment in the organization and any Percentage Commission paid to the employee in these 10 months.

3) Average Salary Balance Leave Credit availed (in Months): Average salary is the average of the 10-month salary received by the employee multiplied by the total number of leaves that are being encashed.

4) Amount Notified by the government: The maximum amount of Leave encashment that can be Tax Exempted was 300000 from 2002 to 2022. In 2023 because of the Increase in the income from salary, this amount changed to 2500000.

Now if we consider an example of an employee who exited on 23 March 2022, who has 45 days available in their Annual Leave of which 30 days are being encashed and per day leave encashment amount is 2300 for the employee. Also, considering the total of the last 10 months' salary is 360000 then the Tax exemption on Leave encashment is considered as follows:

The tax-exempt amount for Leave Encashment is calculated based on the average Basic Salary for the last 10 months and the number of leave encashment days.

Formula:

Exempted Amount = Average Basic Salary for the last 10 months × Leave Encashment Days ÷ 30

Example

• Total Basic Salary for the last 10 months: ₹13,63,097
• Average Basic Salary: ₹13,63,097 ÷ 10 = ₹1,36,309.70
• Leave Encashment Days: 38 days
• Leave in months: 38 ÷ 30 = 1.2667 months
• Total Leave Encashment: ₹2,10,021.67

Hope it is now clear how Tax exemption of Leave encashment is calculated. Need more help? You can refer to the other articles available.