Archive · 3 Sep 2026
Laid off? How Indian severance pay is taxed
When someone loses a job, they may receive money called severance pay.
In India, this money is usually added to their income for that financial year.
They may then have to pay income tax on it.
Calling the payment an exit package does not automatically make it tax-free.
Money received under a qualifying voluntary retirement plan can have an exemption of up to ₹5 lakh, but ordinary layoff severance usually does not qualify.
Gratuity and unused-leave payments may have different tax exemptions.
Employees should check that every part of their final payment is listed separately.
This breakdown helps determine how much money is actually taxable.
Termination-related severance is generally taxed as “profits in lieu of salary” at applicable income-tax slab rates.
The ₹5 lakh exemption for qualifying voluntary retirement schemes generally does not apply to ordinary layoff severance.
Gratuity and leave encashment may receive separate exemptions from termination compensation.
Private-sector gratuity exemptions are subject to a ₹20 lakh limit, while eligible non-government leave encashment exemptions can reach ₹25 lakh.
Employees should ensure their full-and-final settlement separately lists severance, notice pay, gratuity and leave encashment.
- Who
- Employees affected by layoffs or employment termination, including workers receiving severance, gratuity or leave encashment.
- What
- The article explains how severance and other components of a full-and-final settlement may be taxed in India.
- When
- The tax treatment applies in the financial year in which the compensation is received; the article references the Income-tax Act and Rules, 2025.
- Where
- India.
- Why
- To clarify how the structure of an exit package affects taxable income and available exemptions.
- General severance treatment
- Termination-related compensation is generally treated as “profits in lieu of salary” and taxed at applicable slab rates.
- VRS exemption
- A qualifying voluntary retirement scheme may receive an exemption of up to ₹5 lakh, subject to conditions.
- Gratuity limit
- For eligible private-sector employees covered by the Payment of Gratuity Act, the exemption is subject to a ₹20 lakh limit.
- Government gratuity
- Gratuity received by government employees is fully exempt, according to the article.
- Leave encashment limit
- Eligible non-government employees may receive leave-encashment exemption up to ₹25 lakh, subject to applicable rules.
- Government leave encashment
- Government employees generally receive full exemption for leave encashment.
- Recommended documentation
- Termination and relieving documents should separately identify severance, notice pay, gratuity, leave encashment and other payments.