Paying tax on termination payments
All payments you receive as a result of the termination of employment are taxable, regardless of whether such payments are contractual, statutory or voluntary.
There is a tax exemption for the first £50,000 of termination payments.
When you will be taxed
The year in which you will be taxed (the tax trigger point) is when you are entitled to be paid the termination payment. For example, if the agreement was made in writing in December but it stated that you were entitled to be paid in January, then January is the 'tax trigger point'.
Payments not covered by the exemption
The £50,000 excess does not apply to payments that are remuneration or deferred pay (see examples below). This includes:
- bonuses
- holiday pay
- payment in lieu of notice
- gardening leave
- payments while suspended from duties
- pensions
- other payments of a similar nature
All of these payments are also liable to income tax.
Insolvency benefit
The £50,000 exemption does not apply to that part of insolvency benefit paid by social security that relates to unpaid wages, holiday pay and pay in lieu of notice. All these payments are taxable and should be declared on your tax return.
Examples
Example 1 - redundancy settlement with a compensation payment over £50,000
| Types of payment | £ | Tax treatment | £ |
|---|
| Compensation for redundancy | 60,000 | First £50,000 (max) of termination payment tax free | 10,000 |
| Salary | 5,000 | Taxable | 5,000 |
| Bonus | 12,000 | Taxable | 12,000 |
| Payment in lieu of notice | 10,000 | Taxable | 10,000 |
| Holiday pay | 1,000 | Taxable | 1,000 |
Total | 88,000 | Total subject to tax | 38,000 |
| | | Employer deducts tax (for example 16%)
| 6,080 |
Example 2 - redundancy settlement with a compensation payment under £50,000
| Types of payment | £ | Tax treatment | £ |
|---|
| Compensation for redundancy | 40,000 | 40,000 is all tax free | 0 |
| Salary | 5,000 | Taxable | 5,000 |
| Bonus | 12,000 | Taxable | 12,000 |
| Payment in lieu of notice | 10,000 | Taxable | 10,000 |
| Holiday pay | 1,000 | Taxable | 1,000 |
Total | 68,000 | Total subject to tax | 28,000 |
| | | Employer deducts tax (for example 16%)
| 4,480 |
Injury, death and disability payments
Any payment made resulting from injury, death or disability is exempt from tax without limit.
Notice to employers
Do not deduct tax from compensation payments that do not exceed £50,000. If the payment exceeds this sum, only deduct your employee's current effective rate percentage from the remaining balance in excess of the £50,000 exemption.
Tax must be deducted from any other elements of the employee's pay (see the examples above).
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