Section 10(10AA) of income tax act exempts the cash you get for unused leave when you retire or resign, up to ₹25 lakh for a private sector employee, while its neighbour section 10(10) exempts gratuity up to ₹20 lakh. Government employees get both in full without any cap.
Both are lifetime limits, counted across every employer you have had. Both are allowed under the old and the new regime, unlike HRA. Anything above the exempt amount is added to your salary income and charged at your slab rate for the year you receive it. The figures here apply to FY 2025-26 and carry into tax year 2026-27.
Quick facts
Gratuity section
10(10), 1961 ActGratuity cap
₹20 lakh, lifetimeLeave encashment section
10(10AA), 1961 ActLeave encashment cap
₹25 lakh for non government staffGovernment employees
Fully exempt for bothRegime
Allowed in old and new regimeLeave paid while in service
Fully taxable
Section 10(10) of income tax act: gratuity limits
| Employee | Exempt amount is the least of |
|---|---|
| Central or state government, local authority | Whole amount exempt |
| Covered by the Payment of Gratuity Act | Gratuity received; ₹20,00,000; 15 days' salary × years of service |
| Not covered by that Act | Gratuity received; ₹20,00,000; half a month's average salary × completed years |
For an employee covered by the Payment of Gratuity Act, 15 days' salary is worked as last drawn salary × 15 ÷ 26, and a part year of more than six months counts as a full year. For others, average salary means the average of the last ten months, and only completed years count.
Gratuity worked example
Suresh retires from a private company covered by the Payment of Gratuity Act. Last drawn basic plus DA ₹60,000 a month. Service 16 years 7 months, which rounds up to 17 years. Gratuity paid ₹8,00,000.
- Formula amount: ₹60,000 × 15 ÷ 26 × 17 = ₹5,88,462.
- Cap: ₹20,00,000.
- Actual: ₹8,00,000.
- Exempt: the least, ₹5,88,462. Taxable as salary: ₹2,11,538.
Had his employer been outside the Act, the formula would be ₹60,000 × ½ × 16 completed years = ₹4,80,000, so ₹3,20,000 would be taxable.
What section 10(10AA) of income tax act covers
Leave encashment is the payment for earned leave you did not take. Paid while you are still working, it is fully taxable as salary. Paid on retirement or on leaving the job, section 10(10AA) exempts it up to a limit. For a non government employee, the exempt part is the least of:
- the leave encashment actually received;
- ₹25,00,000 (raised from ₹3 lakh, for retirements from FY 2023-24);
- ten months' average salary;
- average monthly salary × unused leave, with leave capped at 30 days for each completed year of service.
Average salary here is basic plus retirement DA and turnover commission over the ten months before retirement.
Leave encashment worked example
Same employee, Suresh. Average salary for the last ten months ₹60,000. He has 200 days of unused leave, within the cap of 30 days × 16 years. His employer pays ₹4,00,000.
- Leave based figure: 200 ÷ 30 × ₹60,000 = ₹4,00,000.
- Ten months' salary: ₹6,00,000.
- Cap: ₹25,00,000.
- Actual: ₹4,00,000. Exempt amount: ₹4,00,000. Nothing is taxable.
Points to check before you sign the settlement
- Lifetime caps: if you took tax free gratuity from an earlier employer, the ₹20 lakh limit shrinks by that amount. The same applies to the ₹25 lakh leave limit.
- Form 16: your employer should show the exempt part under allowances exempt under section 10. Compare it with your own working; see Form 16.
- Relief for arrears: if part of the payout is taxable, relief under section 89 may lower the tax; it needs Form 10E filed before the return.
- Regime choice: these exemptions survive in the new regime, so they do not affect which regime is cheaper much.
Under the Income-tax Act, 2025
For payouts received from 1 April 2026, in tax year 2026-27, gratuity and leave encashment exemptions carry over into the 2025 Act, keeping the caps of ₹20 lakh and ₹25 lakh. The section numbers 10(10) and 10(10AA) belong to the 1961 Act, which still governs a payout received in FY 2025-26. Search terms will keep using the old numbers for some time. If you invest the payout, the capital gains rules apply when you later sell.
Gratuity and leave tax mistakes
| Error | Fix |
|---|---|
| Counting 16 years 7 months as 16 for a covered employee | More than six months rounds up to a full year |
| Ignoring tax free gratuity from an old job | Reduce the ₹20 lakh cap by what was exempt before |
| Claiming 10(10AA) for leave cashed while still employed | Only leave paid on leaving or retiring qualifies |
| Assuming the new regime blocks the exemption | Both exemptions are allowed in the new regime |
Read this as a general outline of how these exemptions are measured. Settlement papers differ, so let a chartered accountant check your figures, and look up current limits on the income tax website.
Sources we checked
- Income-tax Act, 1961, section 10(10)
- Income-tax Act, 1961, section 10(10AA)
- CBDT notification raising the leave encashment limit to ₹25 lakh
- Payment of Gratuity Act, 1972
Frequently asked questions
What is section 10(10AA) of income tax act?
It exempts leave encashment received on retirement or on leaving a job. For non government employees, the exemption is capped at ₹25 lakh over a lifetime; government employees are fully exempt.
How does section 10(10) of the income tax act treat gratuity?
Section 10(10) exempts gratuity. Government employees are fully exempt; others get the least of the actual gratuity, ₹20 lakh and a formula based on salary and years of service.
Is gratuity taxable in the new tax regime?
The exemption works in both regimes. Only the amount above the exempt limit is taxed at your slab rate.
Is leave encashment during service taxable?
Yes. Leave cashed while you are still working is fully taxable as salary. The 10(10AA) exemption is only for leave paid on retirement or resignation.
Is the ₹20 lakh gratuity limit per employer?
No, it is a lifetime limit across all employers. Tax free gratuity received earlier reduces it.