Leave encashment during service vs. at retirement

Leave encashment runs on two completely different tax regimes, not one rule with an exception carved out, and which one applies depends entirely on a single fact: whether you received the money while still employed, or on your way out.

Same payout, opposite tax outcome

Leave encashed while you’re still employed is taxed exactly like regular salary under Section 17(1): fully, with no special treatment at all. Leave encashed at retirement or resignation falls under Section 10(10AA) instead, which can exempt a large portion of it. Same cash, same formula for the amount itself; the tax outcome depends only on which side of that line it falls on.

“Largely tax-free” isn’t a guarantee of “fully”

The retirement-side exemption comes with strings attached. It’s the smallest of four separate limits (the actual amount, a ₹25 lakh lifetime ceiling, 10 months’ average salary, and a cap of 30 leave-days per year of service), and on a large enough encashment relative to salary and tenure, one of those limits can bind well below the full amount. The mechanics of exactly which limit wins are their own topic; the point here is just that “at retirement” doesn’t automatically mean “entirely tax-free.”

Government employees skip this entirely

Central and state government employees don’t go through any of this at retirement — their leave encashment is fully exempt with no ceiling and none of the four limits applying at all. The during-service rule is unchanged for them too, though: encashment received while still employed is taxable for government and private-sector employees alike.