The short answer
A settlement agreement may include several different payments, and they are not all taxed in the same way. The £30,000 exemption is often misunderstood: it does not make every payment connected with leaving a job tax-free. The tax treatment depends on what each payment is for and how it is classified under the rules.
Key takeaways
- The £30,000 exemption applies only to qualifying termination awards, not every payment in a settlement.
- Salary, holiday pay and notice pay are generally taxed as earnings.
- The tax treatment depends on what each payment is for, not simply the label used in the agreement.
Which payments are taxed as earnings
Salary up to the termination date, accrued holiday pay, bonuses already earned and contractual benefits are normally subject to income tax and National Insurance in the usual way. A payment in lieu of notice is also generally taxable as earnings. The rules on post-employment notice pay can tax an amount equivalent to the basic pay the employee would have received during any unworked notice period, even if the agreement describes it as compensation or an ex-gratia payment.
How the £30,000 threshold works
Some qualifying termination awards, such as statutory redundancy pay and additional severance compensation, may benefit from a combined £30,000 income tax exemption. The threshold applies to the qualifying elements of the termination package together; it is not a separate allowance for every payment. The part of qualifying awards above £30,000 is generally taxable. Employer National Insurance may also be due on qualifying termination awards above the threshold.
A simple example
Suppose an employee receives £8,000 in salary and holiday pay, £5,000 as pay in lieu of notice, and £28,000 as a qualifying severance award. The salary, holiday pay and notice payment are normally taxed as earnings. The £28,000 qualifying award may fall within the £30,000 exemption, subject to the full facts and any other qualifying termination payments received. If the qualifying award were £38,000, the excess £8,000 would generally be taxable.
Other payments can have different treatment
A payment for an injury or disability may qualify for a different exemption in limited circumstances, but ordinary distress or hurt feelings connected with dismissal do not automatically qualify. Employer contributions to a registered pension scheme and direct payments for legal advice may also have specific rules. The agreement should identify the purpose and amount of each payment accurately; the label alone does not decide the tax treatment.
Why the wording of the agreement matters
The agreement should set out each payment separately and explain its basis. The employer is responsible for operating PAYE where required, but the employee may still have tax to pay depending on their circumstances. A settlement can also affect tax in the year of receipt, benefits or pension arrangements. Ask for a clear breakdown before signing and consider independent tax advice where the figures are significant or unusual.
Take advice before accepting
A settlement agreement is legally binding once signed. An employee must receive independent advice on its terms from an authorised adviser for it to waive specified employment claims. The adviser can check the payment breakdown, notice calculation, deductions, reference wording and other terms, but tax advice may need to come from an accountant or tax specialist.
Frequently asked questions
Is every settlement agreement payment tax-free up to £30,000?
No. The threshold applies to qualifying termination awards. Salary, holiday pay, bonus and notice pay are generally taxable as earnings.
Does payment in lieu of notice count towards the £30,000 exemption?
It is generally taxable as earnings. Post-employment notice pay rules may also apply where notice is not worked.
What happens if a qualifying termination award is more than £30,000?
The excess is generally taxable, subject to the detailed rules and the nature of the payments.
Speak to The Legal Practice Solicitors
Our Employment Law team advises employers on workplace policies, contracts and employment-law compliance. We can help you review your current bereavement arrangements and prepare for the forthcoming statutory changes.
Telephone: 020 8903 7017
Email: employmentlaw@thelegalpractice.co.uk
Office: 122-126 Wembley Park Drive, Wembley Park, London HA9 8HP
Legal information
This article is intended for general information only and does not constitute legal advice or create a solicitor-client relationship. The law and individual circumstances can change the outcome. Obtain specific advice before acting. This article concerns the law of England and Wales.
