>Should the company have cut separate checks for severance and leave encashment? I believe the severance and leave encashment are being recognized as bonuses and taxed accordingly.

They can do that, or they can lump them together. It's their choice. Lumping them together benefits you in that while you pay extra taxes now, you won't end up owing taxes.

This happens with bonuses too. It's annoying, but you'll get some of it back when you file your taxes. You have no options here.