Termination Payments
Overview 📘
When an employee leaves, they may receive several different payments as part of their final pay or a settlement agreement.
Each payment must be considered separately. Some payments are taxed as normal earnings, while genuine compensation for loss of employment may qualify for the £30,000 tax exemption.
✅ Payments Taxed as Normal Earnings
Payments relating to work already performed or the employee’s contractual entitlements are subject to Income Tax and National Insurance in full (with the exception of contractual redundancy pay).
These include:
- Final salary.
- Bonuses and commission.
- Accrued holiday pay.
- Gardening leave.
- Payment in lieu of notice (PILON).
- Post-employment notice pay (PENP).
- Any other payment due under the employment contract.
💡 The £30,000 exemption does not apply to these payments.
💷 Payments That May Be Tax-Free
Genuine compensation paid because the employment is ending may qualify for the termination payment exemption.
This can include:
- Contractual redundancy pay.
- Statutory redundancy pay.
- Genuine ex gratia compensation.
- Compensation for loss of employment or wrongful dismissal.
The first £30,000 of qualifying termination payments is normally free from Income Tax and National Insurance.
Any amount above £30,000 is:
- Subject to Income Tax.
- Subject to employer Class 1A National Insurance.
- Not subject to employee National Insurance.
🔍 Notice Pay
If an employee does not work their full notice period, some of the termination payment may need to be treated as taxable notice pay.
This is known as post-employment notice pay, or PENP. It is subject to Income Tax and both employer and employee National Insurance, even where the payment is described as compensation or ex gratia.
A specific calculation may be required to determine the taxable amount.
📊 Example
An employee receives:
- £4,000 final salary and holiday pay.
- £25,000 redundancy compensation.
The £4,000 is taxed through payroll in full.
The £25,000 redundancy payment can normally be paid tax-free because it falls within the £30,000 exemption.
💡 Key Points
- A settlement agreement does not automatically make a payment tax-free.
- Each part of the termination package must be considered separately.
- Salary, holiday pay, bonuses and notice pay are always taxable.
- Only qualifying compensation payments can benefit from the £30,000 exemption.
- The tax treatment should be agreed before the payment is processed through payroll.
Termination payments can be complex, particularly where notice pay or a settlement agreement is involved. Please seek advice before finalising the package if you are unsure.