Report retirement leave encashment twice in the return: include the payment in salary income, then claim only the qualifying exemption under section 10(10AA) in the Salary schedule. Central and State Government employees generally receive full exemption for earned-leave encashment at retirement. For other employees—including public-sector undertaking (PSU) employees—the exempt amount is the least of four limits and cannot exceed ₹25,00,000. The payment date, employer category, calculation and ITR form must all match your employer’s salary certificate and the current assessment-year utility.
First determine whether the payment qualifies
Section 10(10AA) addresses the cash equivalent of earned leave standing to an employee’s credit when employment ends on retirement, whether on superannuation or otherwise. The retirement condition is critical. A leave-encashment payment received while you continue working is not automatically covered by the retirement exemption.
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Retirement or resignation-related payment
Start by checking the event recorded by your employer: retirement, superannuation, termination or another separation event. The salary certificate and payroll records should show the payment as leave encashment and identify the relevant financial year. Do not rely only on the date the money reached your bank account; reconcile the payment to the year in which the employer reported it.
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Keep the retirement or separation order, relieving letter and final payroll statement together. The statutory wording focuses on earned leave standing to your credit and cash received at retirement. A payment described informally as a “leave settlement” may need clarification from payroll if the document does not identify whether it arose on retirement or during active service.
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Encashment during continuing employment
Encashment while you remain employed must be considered separately from retirement encashment. The official salary guidance discusses relief under section 89(1) in its leave-encashment material, but eligibility depends on the facts and the rules for the relevant return year. Do not enter a retirement exemption merely because the payslip uses the words “leave encashment.”
Ask the employer whether the amount was included in taxable salary and whether any relief or adjustment was reflected in Form 16. If the payment was made during service, retain the payroll explanation and examine the applicable provisions for that year rather than forcing it into the retirement field.
How the exemption differs by employer category
| Case | Section 10(10AA) treatment | What to report |
|---|---|---|
| Central Government employee retiring with earned-leave encashment | Fully exempt under the department’s current salary guidance. | Include the salary payment and claim the qualifying exempt amount in the Salary schedule. |
| State Government employee retiring with earned-leave encashment | Fully exempt under the department’s current salary guidance. | Include the salary payment and claim the qualifying exempt amount in the Salary schedule. |
| PSU employee retiring with earned-leave encashment | Treated as a non-government employee for the current ITR-1 validation; the ₹25,00,000 maximum applies along with the other “least of” limits. | Calculate the permitted exemption and report it against the leave-encashment salary amount. |
| Private-sector or other non-government employee retiring with earned-leave encashment | Exemption is the least of the four statutory limits described below, including ₹25,00,000. | Include the payment in salary and claim only the calculated exempt portion. |
| Employee receiving leave encashment while still employed | The retirement exemption should not be assumed. | Follow the applicable salary-tax treatment for the payment and check whether any separate relief is available. |
“Government employee” in this context means a Central or State Government employee. Do not automatically treat every public-sector worker as a government employee; the current return validation expressly includes PSU employees among non-government employees for the ₹25,00,000 limit.
The classification is tested for the employer making the payment. A former employee who changes jobs should not combine leave balances or salary figures from different employers when applying the current-employer service limit. Obtain a separate certificate if more than one employer paid salary during the year.
Calculate the exemption for a non-government employee
For a non-government employee, the exempt amount is the least of these four figures:
- The actual leave-encashment amount received at retirement.
- The number of eligible unutilized earned-leave days multiplied by average monthly salary.
- Ten months’ average salary.
- ₹25,00,000, the statutory ceiling stated in the Income Tax Department’s current salary guidance and in the AY 2026–27 ITR-1 validation rules.
Limit on leave days
The department’s guidance says the leave entitlement used in the calculation cannot exceed 30 days for each completed year of service with the current employer. Use the eligible leave balance and service period shown in employer records; do not substitute a more generous leave figure from another employer or an internal policy that exceeds the statutory calculation limit.
For example, 12 completed years gives a service-based ceiling of 360 days. If the leave account shows 420 days, only the amount permitted under the 30-days-per-completed-year rule is used in the second limit. If the balance is 240 days, use 240, provided the employer confirms that these are eligible earned-leave days.
What counts as average salary
Average salary is the average for the last ten months immediately before retirement. For this calculation, salary means:
- Basic pay;
- Dearness allowance, to the extent it forms part of retirement benefits; and
- Turnover-based commission.
Use the figures and definitions supported by the employer’s payroll records. Do not include every allowance simply because it appears on a payslip. Request a month-by-month statement where pay changed during the final ten months, so the average can be reproduced if the return is reviewed.
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Worked example
Assume a retiring non-government employee receives ₹18,00,000 as leave encashment, has 240 eligible leave days after applying the service-based limit, and has an average monthly salary of ₹1,20,000 for the last ten months.
| Limit | Calculation | Amount |
|---|---|---|
| Actual amount received | As reported by the employer | ₹18,00,000 |
| Eligible leave × average monthly salary | 240 × ₹1,20,000 | ₹2,88,00,000 |
| Ten months’ average salary | 10 × ₹1,20,000 | ₹12,00,000 |
| Statutory ceiling | Non-government maximum | ₹25,00,000 |
The least amount is ₹12,00,000, so that is the section 10(10AA) exemption in this illustration. The remaining ₹6,00,000 is not made exempt by the ₹25,00,000 ceiling and must remain in the taxable salary calculation according to the employer’s reporting.
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Second example: the receipt and ceiling are the limiting figures
Suppose the actual retirement payment is ₹28,00,000, eligible leave is 180 days, and average monthly salary is ₹90,000. The four figures are ₹28,00,000, ₹1,62,00,000 (180 × ₹90,000), ₹9,00,000 and ₹25,00,000. The exemption is ₹9,00,000 because ten months’ average salary is the lowest. In another case, if ten months’ average salary and the leave-days result are above ₹25,00,000 and the actual payment is ₹30,00,000, the ceiling limits the exemption to ₹25,00,000.
Step-by-step: enter leave encashment in the return
- Identify the financial year and assessment year. For a return filed for income earned in financial year 2025–26, the assessment year is 2026–27. Confirm the year shown on the employer’s salary certificate and use the corresponding current return utility.
- Confirm the payment timing. Establish whether the encashment arose on retirement or while employment continued. Keep the retirement or separation document if the payment is being treated under section 10(10AA).
- Classify the employer. Confirm whether the employer is the Central Government, a State Government, a PSU or another employer. This classification determines whether the full-exemption rule or the non-government calculation applies.
- Collect the salary and leave figures. Obtain the salary certificate, Form 16 and payroll statement showing the leave-encashment amount under salary. For a non-government calculation, obtain the eligible leave days, completed service years, last-ten-month salary details and the components used to determine average salary.
- Calculate the permitted exemption. Government employees should claim the amount supported by the retirement payment and employer records. Other employees must apply all four “least of” limits and use the lowest result.
- Open the Salary schedule in the applicable ITR. Enter the salary information, including the leave-encashment amount reported under section 17(1), in the fields provided by the current form or utility.
- Enter the exempt portion under section 10(10AA). In the current ITR-1 validation, the field is labelled “Exempt Allowance u/s 10(10AA)-Earned leave encashment on retirement.” Other forms or later utility versions may use different wording or field order; select the matching section 10(10AA) field rather than copying the ITR-1 screen into another form.
- Run validation and reconcile totals. The current ITR-1 validation constrains the section 10(10AA) exemption against the related “Leave Encashment” salary amount under section 17(1). Correct any exemption that exceeds the reported receipt before proceeding.
- Check the form eligibility. Salary income by itself does not guarantee that ITR-1 is available. Apply the current AY 2026–27 eligibility conditions, including residency, income limits, income types and exclusions. If you do not qualify for ITR-1, use the applicable ITR form and its Salary schedule.
- Review the final computation before submission. Compare the return’s salary total, exempt allowance and taxable salary with Form 16, the salary certificate and payroll records. Save the supporting documents with your tax files.
How to build a calculation worksheet
Make a short worksheet before opening the utility. Record the employer name and category, retirement date, financial year, leave-encashment receipt, completed service years, eligible leave days, each of the last ten months’ qualifying salary figures and the resulting average. Then list the four limits in separate rows and highlight the smallest number. This prevents the common mistake of entering the ceiling rather than the calculated exemption.
Keep the worksheet’s figures in the same units as the return, normally whole rupees. If payroll uses a different rounding convention, follow the employer certificate and ensure that the final exempt amount does not exceed the reported receipt. The worksheet should also show the taxable balance: the leave-encashment salary amount less the section 10(10AA) exemption, subject to the employer’s salary computation.
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How the Salary schedule should reconcile
The key relationship is between the salary amount reported as leave encashment under section 17(1) and the exempt allowance claimed under section 10(10AA). The exempt amount cannot exceed the related salary receipt. If your employer reports ₹12,00,000 of leave encashment, entering ₹15,00,000 as the exempt allowance will fail the current ITR-1 validation and is unsupported by the salary records.
Entering the full payment as exempt also creates a problem when only part qualifies. For example, if a non-government employee receives ₹30,00,000 but the four-limit calculation produces ₹20,00,000, the return should show the payment in salary and claim ₹20,00,000 as the section 10(10AA) exemption. The balance remains subject to the normal salary computation.
If Form 16 and the salary certificate show different amounts, pause the filing. Ask the employer for a corrected certificate or written reconciliation, then use the corrected figures consistently in the return. Do not solve a document mismatch by increasing the exempt allowance manually.
Choosing the correct ITR form for AY 2026–27
The department’s AY 2026–27 guidance limits ITR-1 to qualifying resident individuals with the specified income profile. It also lists circumstances that make a taxpayer ineligible. Review the current eligibility help and utility instructions before selecting ITR-1, particularly if you have income in addition to salary, special assets, business income, or another listed exclusion.
When ITR-1 is appropriate, use its current Salary schedule and the exact field label supplied by the utility. When another ITR is required, use that form’s Salary schedule and section 10(10AA) field. Field positions and labels can change between forms and utility releases, so an old screenshot is not a reliable filing instruction.
Common mistakes and how to fix them
Claiming the ₹25 lakh limit automatically
Problem: Entering ₹25,00,000 as the exemption whenever the employee is outside the Central or State Government category.
Fix: Calculate all four limits. Claim the lowest amount, which may be below ₹25,00,000.
Treating a PSU employee as a government employee
Problem: Applying full exemption because the employer is government-owned or publicly controlled.
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Random freezes, missing sound and display glitches usually trace back to one bad driver. Find and replace yours safely.Free scan · under a minuteFix: Check the employer category used by the current rules. The AY 2026–27 ITR-1 validation treats PSU employees as non-government employees for the ₹25,00,000 maximum.
Claiming retirement exemption for an in-service payment
Problem: Using section 10(10AA) merely because the payslip says leave encashment.
Fix: Verify that the payment relates to retirement or another qualifying end-of-service event. If employment continued, review the applicable treatment instead.
Using total leave balance without the service limit
Problem: Multiplying every accumulated leave day by average salary.
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Fix: Apply the guidance’s maximum of 30 days for each completed year of service with the current employer, then use the eligible balance in the “least of” calculation.
Using the wrong salary components
Problem: Including allowances that are not part of the section 10(10AA) salary definition.
Fix: Use basic pay, qualifying dearness allowance and turnover-based commission, averaged over the last ten months before retirement, as supported by payroll records.
Exempt amount higher than the reported receipt
Problem: The utility rejects the return or the return does not agree with Form 16.
Fix: Recheck the leave-encashment amount under section 17(1), correct the exemption field and run validation again. If the employer certificate is wrong, request a corrected document before filing.
Choosing ITR-1 without checking eligibility
Problem: Selecting ITR-1 solely because all income appears to be salary.
Fix: Apply the full AY 2026–27 eligibility and exclusion criteria. Use the form prescribed for your actual income and circumstances.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.Documents to retain
- Form 16 and the employer’s salary certificate;
- Retirement, superannuation or separation documentation;
- Payroll statement showing the leave-encashment amount under section 17(1);
- Leave account showing the eligible unutilized earned-leave balance;
- Service-period record used for the 30-days-per-completed-year limit;
- Last ten months’ salary details and the calculation of average salary;
- The worksheet showing each of the four non-government limits; and
- The filed return, computation and utility validation result.
Tax return utilities and instructions can change by assessment year. Download the current AY 2026–27 form, validation rules and instructions from the Income Tax Department and compare the labels with your employer documentation.
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- Was the payment made at retirement or while employment continued?
- Is the employer Central Government, State Government, PSU or another employer?
- Does the payment amount in the return equal the amount reported by the employer under section 17(1)?
- For a non-government employee, were actual receipt, eligible leave multiplied by average monthly salary, ten months’ average salary and ₹25,00,000 all compared?
- Is the section 10(10AA) exemption entered in the current Salary schedule?
- Is the selected ITR form permitted for your AY 2026–27 income and circumstances?
- Do the final salary and exemption totals reconcile to Form 16 and payroll records?
Frequently Asked Questions
How do I show leave encashment in my ITR?
Include the leave-encashment amount in salary under section 17(1), then enter only the eligible section 10(10AA) exemption in the applicable ITR Salary schedule. The exempt amount must not exceed the related salary receipt.
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Is leave encashment tax-free when I retire?
Central and State Government employees receive full exemption for qualifying earned-leave encashment at retirement under the department’s current guidance. Other employees must apply the four-limit calculation, including the ₹25,00,000 ceiling.
Is the ₹25 lakh amount available automatically to a private-sector employee?
No. ₹25,00,000 is only one of four limits. The exempt amount is the least of the actual receipt, eligible leave multiplied by average monthly salary, ten months’ average salary and ₹25,00,000.
Are PSU employees treated as government employees for this exemption?
The current AY 2026–27 ITR-1 validation treats PSU employees as non-government employees for the ₹25,00,000 maximum. Apply all four limits unless the applicable rules and employer records establish otherwise.
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Can I claim section 10(10AA) for leave encashed while I am still working?
Do not assume so. The cited exemption concerns earned-leave encashment at retirement or another qualifying end-of-service event. In-service payments require separate salary-tax analysis; the department’s material mentions section 89(1) relief, but eligibility depends on your facts and the relevant year’s rules.
What salary is used for the ten-month calculation?
Use the average for the last ten months before retirement. The relevant salary consists of basic pay, dearness allowance to the extent it forms part of retirement benefits, and turnover-based commission.
What if my exemption is higher than the leave-encashment amount in Form 16?
Reduce the exemption to no more than the related section 17(1) salary amount and reconcile the figures with payroll. If the employer document is incorrect, obtain a corrected certificate before filing.
Which ITR form should I use?
Use ITR-1 only if you satisfy the current AY 2026–27 eligibility conditions for residency, income profile and exclusions. Otherwise select the applicable ITR and its Salary schedule; the field order may differ.
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The Bottom Line
For AY 2026–27, report retirement leave encashment in salary and claim the section 10(10AA) exemption separately. Central and State Government employees generally receive full exemption. PSU and private-sector employees must use the least of the actual receipt, eligible leave multiplied by average monthly salary, ten months’ average salary and ₹25,00,000. Reconcile the claim to section 17(1), Form 16 and the current ITR utility before submitting.
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