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To claim leave-encashment exemption under Section 10(10AA), report the receipt under salary in your AY 2026–27 income-tax return and claim only the amount allowed by the rules. At retirement, Central and State Government employees receive full exemption under the Income Tax Department’s guidance. For other employees, the exemption is the least of four amounts: the payment received, the eligible earned-leave cash equivalent, 10 months’ average salary, or the available part of the ₹25 lakh ceiling.
This guide covers income earned in FY 2025–26 and reported for AY 2026–27. That return year is governed by the Income-tax Act, 1961 and uses the old ITR forms; the Income-tax Act, 2025 applies to Tax Year 2026–27, which begins with income earned in FY 2026–27. The Income Tax Department’s AY 2026–27 guidance is the relevant starting point for choosing a return form.
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Does Section 10(10AA) cover your leave-encashment payment?
Section 10(10AA) concerns the cash equivalent of earned leave standing to an employee’s credit when employment ends at retirement, whether through superannuation or otherwise. The treatment depends first on when you received the payment and then on your employer category.
| Payment situation | How it is treated |
|---|---|
| Earned-leave encashment at retirement; Central or State Government employee | Fully exempt under the Income Tax Department’s guidance. |
| Earned-leave encashment at retirement; employee in another employer category | Exemption is limited to the least of the four statutory amounts described below. |
| Leave encashment received while still employed | Taxable as salary; do not claim the retirement exemption as if it were a retirement payment. Relief under Section 89 may be available. |
The distinction between Central or State Government employment and other employment matters. Do not assume that every public-sector, local-government or government-linked employer automatically belongs in the Central or State Government branch. Use the correct employer category for your circumstances and the active return fields; if the category is unclear, confirm it with your employer or a tax professional before filing. The AY 2026–27 ITR-2 validation rules distinguish Central and State Government categories from other employers.
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In practical terms, begin by identifying the event connected to the payment. A retirement or other qualifying cessation-of-employment payment is not treated like leave encashment paid while you remain employed. The label on a payslip or employer statement does not, by itself, decide which branch applies. Confirm the timing and circumstances with your employer records, and do not convert an in-service payment into a retirement claim simply because it relates to earned leave.
How much leave encashment is exempt for a non-government employee?
For an employee outside the Central and State Government categories, the exempt amount is the least of these four figures:
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- Cash equivalent of eligible unutilized earned leave. Use eligible leave days and the average monthly salary defined for this calculation.
- Ten months’ average salary. Average salary is based on the 10 months immediately before retirement.
- ₹25,00,000 ceiling. This is the non-government limit, reduced by relevant Section 10(10AA)(ii) exemption already allowed in earlier years and subject to the aggregate rule for payments from multiple employers in the same previous year.
The Income Tax Department’s employee-benefit guidance gives this least-of-four calculation. The ₹25 lakh ceiling was notified for non-government salaried employees with effect from 1 April 2023 by the Central Board of Direct Taxes.
The words “least of” are important: compare all four figures, then use the smallest as the exemption. They are independent checks, not alternatives from which you may choose the most favourable. A high actual payment does not override a lower eligible-leave figure; a large eligible balance does not override the 10-month salary limit; and even if those first three amounts are higher, the available ceiling may be lower because of earlier exemptions.
What counts as eligible leave and average salary?
For this calculation, the earned-leave entitlement used cannot exceed 30 days for each year of service with the current employer. Use the eligible unutilized earned-leave balance, not an employer’s larger policy ceiling without checking that statutory cap. The relevant average salary is for the 10 months immediately before retirement.
For Section 10(10AA), salary means basic pay, dearness allowance to the extent it forms part of retirement benefits, and turnover-based commission. Do not simply use gross monthly pay or copy a salary figure from another tax calculation without checking which components belong in this definition. A practical way to express the leave-balance limit is to convert the eligible days into months (eligible days divided by 30) and multiply by the defined average monthly salary. Use employer records to establish the eligible leave balance and the salary components.
To work through this limit, first establish your service years with the current employer and apply the 30-days-per-year entitlement restriction. Then identify the eligible unutilized earned-leave days shown in the employer’s records. Convert those days into a monthly equivalent using 30 days per month, and multiply by the defined average monthly salary. This produces the leave-balance figure to compare with the other three limits. It does not replace the other checks, and it is not a reason to count leave beyond the service-based cap.
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For the salary-based figures, use the 10 months immediately preceding retirement as the averaging period. Check which amounts in the salary records are basic pay, qualifying dearness allowance, or turnover-based commission. Other components should not be included merely because they appear in gross compensation: the Department’s definition is specific. If records do not clearly show whether dearness allowance forms part of retirement benefits or how a salary component is classified, confirm the treatment before completing the calculation.
Illustrative calculation
Suppose, purely as an example, a non-government employee receives ₹9 lakh at retirement, has 200 eligible unutilized earned-leave days, and has average monthly salary of ₹1 lakh under the statutory definition. Assume the employee has at least enough service for all 200 days to fit within the 30-days-per-year entitlement cap, and has not used any of the ₹25 lakh ceiling in an earlier year. The leave-balance figure is about ₹6.67 lakh (200 ÷ 30 × ₹1 lakh); 10 months’ average salary is ₹10 lakh; actual receipt is ₹9 lakh; and the ceiling is ₹25 lakh. The exemption is therefore the lowest figure, about ₹6.67 lakh. The remaining ₹2.33 lakh of the payment does not become exempt under this calculation and must be treated accordingly in the salary computation.
The figures in this example are hypothetical, not a taxpayer-specific calculation. If any of the four limits is lower in your case, that lower figure controls. A larger actual receipt, a large leave balance or a ₹25 lakh headline ceiling does not by itself establish the amount you can exempt.
For another illustration of how the limits interact, imagine the same hypothetical facts but with an earlier Section 10(10AA)(ii) exemption of ₹20 lakh. The remaining ceiling would be ₹5 lakh, so it would become lower than the ₹6.67 lakh leave-balance figure and would cap the exemption at ₹5 lakh, assuming the other facts remain unchanged. The point is not to use the ceiling in isolation, but to recalculate all four figures whenever prior claims or other same-year payments change the available amount.
How do previous claims and multiple employers affect the ₹25 lakh limit?
The ₹25 lakh amount is not a fresh allowance for every employer or every retirement. The CBDT says the ceiling is reduced by Section 10(10AA)(ii) exemption already allowed in any previous year or years. It also says that when a non-government employee receives relevant payments from more than one employer in the same previous year, the aggregate exemption cannot exceed ₹25 lakh.
For example, if ₹8 lakh of the relevant exemption was allowed in a previous year, the remaining ceiling for this purpose would be ₹17 lakh, before applying the other three limits. If payments from two employers fall in the same previous year, calculate the aggregate with both payments in view rather than treating each employer’s payment as having its own separate ₹25 lakh ceiling. Keep prior returns or other records that show what exemption was already allowed; an employer’s current Form 16 may not by itself establish your prior-year usage.
These cumulative and aggregate rules are in the CBDT notification announcement. The limit is only one part of the calculation: the actual receipt, eligible leave cash equivalent and 10-month average-salary figure can each result in a lower exemption.
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Keep the two situations distinct when checking the ceiling. An exemption allowed in an earlier year reduces the remaining amount available, while relevant payments from multiple employers in the same previous year must be considered together for the aggregate limit. Neither situation creates a separate ₹25 lakh allowance for each payment. If you have both prior claims and multiple current-year receipts, account for both when working out the available ceiling, then compare it with the receipt, leave-balance and salary limits.
Where do you show leave encashment in the AY 2026–27 ITR?
Report the payment under salary and claim the permitted Section 10(10AA) exemption in the exempt-allowance area of Schedule Salary. The return’s validation rules link the exemption claim to the leave-encashment amount reported under salary, so the salary receipt and exemption should reconcile.
- Choose the correct return form for your full tax situation. Do not select a form solely because you received salary or because you are claiming this exemption. The Income Tax Department lists restrictions on ITR-1; check the AY 2026–27 return applicability guidance against all your income and other circumstances.
- Reconcile the receipt with employer records. Compare the leave-encashment payment with your salary statement and Form 16. Check the amount actually received and whether the payment was made at retirement or during employment.
- Enter the receipt in Schedule Salary. Use the salary component or dropdown identified as “Leave Encashment” in the active AY 2026–27 return utility. Do not omit the receipt merely because some or all of it qualifies for exemption.
- Calculate and enter the exemption separately. For a non-government employee, work out all four limits and enter no more than the least amount. Account for earlier relevant claims and other employers’ payments in the same previous year. For an eligible Central or State Government retirement case, follow the applicable exemption treatment and employer-category field.
- Check the completed salary schedule and tax computation. Confirm the claimed exemption does not exceed the leave-encashment salary amount and that the receipt and exemption are consistent with your records. Resolve a validation error by checking the amount and employer-category fields rather than increasing a claim to make the numbers fit.
The official AY 2026–27 ITR-1 validation rules and ITR-2 validation rules treat the Section 10(10AA) exemption as linked to leave encashment reported as salary. The ITR-2 rules also impose the ₹25 lakh maximum for employer categories other than Central or State Government. Validation is a field-level check, not a substitute for calculating the statutory amount you qualify to claim.
Exact screen labels can change with the return utility version. Use the active AY 2026–27 Schedule Salary fields rather than relying on a screenshot or instructions for a different assessment year. The Department’s Income Tax Forms page provides its official forms and related resources.
One useful way to review the entry before filing is to read the salary schedule as a reconciliation: the gross leave-encashment receipt should be present, and the exemption should be a separate, supported amount no greater than that receipt. Check that the return’s employer category agrees with the facts and that a non-government claim reflects the lowest of the four calculations. A validation message can identify a mismatch between fields, but it does not decide whether a payment qualifies as retirement leave encashment or whether the amount is substantively exempt.
What records should you keep for the exemption?
Keep the documents that let you reproduce each figure in the claim: the employer’s salary statement and Form 16; the leave-encashment payment details; the employer’s leave-balance and service records; salary details for the 10 months before retirement; and records of any earlier Section 10(10AA)(ii) exemptions. If payments came from more than one employer in the same previous year, retain the details for each payment so the aggregate can be checked.
For a non-government claim, the most useful record is a calculation sheet showing the four limits side by side and identifying which one is the lowest. Record how you determined eligible leave days, applied the 30-days-per-year cap, selected the statutory salary components, and reduced the ceiling for earlier claims. This makes it easier to explain the return entry if an employer statement and your own exemption calculation do not match.
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For in-service leave encashment, keep the payment and salary records distinct from a retirement claim. The Department’s salary guidance on leave encashment says an amount received during employment is fully taxable and identifies possible relief under Section 89; it is not the retirement exemption calculation described above.
For a payment connected with retirement, retain enough information to establish the payment date and circumstances as well as the amounts. The leave balance and service period support the eligible-days calculation; salary records for the 10-month period support the averaging figure and salary components; and prior return records support the remaining-ceiling calculation. Where two employers paid leave encashment in the same previous year, organize the records together so the combined claim is visible rather than reviewing each Form 16 in isolation.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.What common mistakes can reduce or invalidate the claim?
- Claiming the exemption for an in-service payment: the retirement exemption does not apply simply because the payment is called leave encashment. The timing and circumstances matter.
- Exempting the whole payment automatically: outside the Central and State Government retirement branch, calculate all four limits and use the lowest.
- Treating ₹25 lakh as a per-employer allowance: prior exemptions reduce the available ceiling, and payments from multiple employers in the same previous year are subject to an aggregate ceiling.
- Using all accumulated leave without the entitlement cap: eligible earned-leave entitlement cannot exceed 30 days per year of service with the current employer.
- Using gross salary for the averaging figure: the statutory salary definition is specific. Include basic pay, qualifying dearness allowance and turnover-based commission, rather than assuming every salary component qualifies.
- Claiming an exemption without reporting the receipt: the return validation rules connect the exempt amount to the salary amount entered as leave encashment.
- Choosing an ITR form based only on this payment: form eligibility depends on the taxpayer’s full circumstances, and ITR-1 has restrictions.
If the return utility flags a mismatch, compare the leave-encashment amount in Schedule Salary with the employer’s records, verify the employer category, and recalculate the exempt amount. Do not treat a passing validation check as proof that the amount is legally exempt; equally, a rejected validation does not tell you to alter the underlying facts.
Another common source of error is treating a payroll figure as the final exemption figure. An employer’s reporting and your return claim must reconcile, but the statutory calculation can depend on eligible days, the salary definition, prior exemptions and other same-year receipts. If an employer has used a different amount, identify the underlying figure that differs and keep supporting records for your return position rather than copying a number without checking it.
Frequently asked questions
How much leave encashment is tax-free on retirement?
For Central and State Government employees, the Department’s guidance describes retirement earned-leave encashment as fully exempt. For other employees, the exemption is the least of actual receipt, eligible leave cash equivalent, 10 months’ average salary and the available portion of the ₹25 lakh ceiling. The individual figures depend on the payment, leave, salary, service and prior-claim records.
Where do I show leave encashment in my ITR?
Report it under salary in Schedule Salary using the active AY 2026–27 utility’s “Leave Encashment” field or component, then claim the eligible Section 10(10AA) exemption separately in the exempt-allowance area. Reconcile both amounts with employer records and the applicable calculation.
Does the ₹25 lakh limit apply separately to each employer?
No. The CBDT says the limit is reduced by relevant exemptions allowed in prior years, and payments from multiple employers in the same previous year are subject to an aggregate ₹25 lakh ceiling.
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Can I claim Section 10(10AA) if my employer paid leave encashment while I was still working?
No—the retirement exemption is not the treatment for a payment received during employment. The Income Tax Department’s salary guidance treats in-service leave encashment as fully taxable and notes that Section 89 relief may be available.
Does the Income-tax Act, 2025 apply to my AY 2026–27 return?
No. AY 2026–27 covers income earned in FY 2025–26 and is governed by the Income-tax Act, 1961 using the old ITR forms. The 2025 Act applies to Tax Year 2026–27, beginning with income earned from FY 2026–27.
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No. For a non-government employee, ₹25 lakh is only one of four limits, and it may be reduced by earlier Section 10(10AA)(ii) exemptions. The exempt amount is the least of all four figures, not automatically the ceiling.
Does an employer’s Form 16 prove the amount I can claim?
Form 16 and the salary statement help reconcile the receipt, but the exemption still depends on the applicable employer category and, for a non-government employee, the leave, salary, prior-claim and multiple-employer limits. Keep records that support each part of the calculation.
Frequently Asked Questions
Can I claim Section 10(10AA) if my employer paid leave encashment while I was still working?
No—the retirement exemption is not the treatment for a payment received during employment. The Income Tax Department’s salary guidance treats in-service leave encashment as fully taxable and notes that Section 89 relief may be available.
Does the ₹25 lakh limit apply separately to each employer?
No. The CBDT says the limit is reduced by relevant exemptions allowed in prior years, and payments from multiple employers in the same previous year are subject to an aggregate ₹25 lakh ceiling.
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No. AY 2026–27 covers income earned in FY 2025–26 and is governed by the Income-tax Act, 1961 using the old ITR forms. The 2025 Act applies to Tax Year 2026–27, beginning with income earned from FY 2026–27.
How much leave encashment is tax-free on retirement?
Central and State Government employees receive full exemption under the Income Tax Department’s guidance. Other employees can exempt only the least of actual receipt, eligible leave cash equivalent, 10 months’ average salary and the available ₹25 lakh ceiling.
Where do I show leave encashment in my ITR?
Report the receipt under salary in Schedule Salary using the active AY 2026–27 “Leave Encashment” field or component, and claim the eligible Section 10(10AA) amount separately in the exempt-allowance area.
The Bottom Line
Bottom line: For AY 2026–27, report leave encashment under salary and claim the Section 10(10AA) exemption separately. Government retirement cases and in-service payments have different treatment; for other retirement cases, claim only the least of the four limits, taking account of the 30-day-per-year leave cap, earlier claims and any same-year payments from other employers.
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