When a termination payment is fully taxable

Termination payments can be difficult to understand. Contact Clarity Simplicity’s employment solicitors who can help you get through the process hassle-free.

What are termination payments?

Severance payments made to employees upon termination of their employment are known as termination payments. These may occur as a result of a number of events, including redundancy, retirement, disability-related departure, or actual or constructive dismissal.

Termination payments must be taxed correctly

  • If termination payments are not properly taxed, HM Revenue & Customs (HMRC) has the right to pursue the business for unpaid tax, NICs, penalties, and interest.
  • A company should take into account both income tax and NICs. The business is required to pay both the employer’s and the employee’s NICs on payments that are considered earnings from employment. This may dramatically raise the settlement expenses.
  • The business will generally be liable for the tax, NICs not deducted, and interest and penalties if it fails to withhold these from a termination payout. Further fines could be assessed if PAYE returns are not delivered on time (or at all).
  • Both the company and the terminated employee will desire that the termination payout be properly designed to:
    • reduce the liability of tax; and
    • rise certainty for avoiding future liability 

How much of the termination payment is taxable?

The type and amount of a termination payment will determine how much of it is taxable. Payments can be divided into several categories, including:

Amounts to which the employee was legally entitled or that were related to their past or future work. Salary payments, contractual bonuses or commissions, contractual payments in lieu of notice (PILONs), and automated PILONs are examples of items that are typically fully taxed.

Restrictive covenants are something to take into account. This is completely taxed. Payments made outside of a contract as a result of termination and redundancy. Taxes are not due on the first £30,000. These include payments for statutory and non-statutory redundancy, non-contractual benefits in kind provided upon termination, damages for wrongful dismissal and payments on account of damages, compensation for unfair dismissal, and compensation for discrimination made in connection with the termination to compensate for financial loss.

Payments in cases where a disability or a discrimination claim unrelated to the termination cause the termination. They are limitless and tax-free. Before or after termination, employees may be eligible to exercise stock options and receive share awards. The tax and NICs obligations will depend on a variety of variables, such as the period of ownership, the cause for the end of the employment relationship, and whether the plan has HMRC approval.

A cash cancellation or compensation payment will be fully taxable.

  • Employer contributions to registered pension schemes.
  • Under the restrictions of the yearly contribution cap, these may be made tax-free.

Tax-free benefits that can be provided to employees

The following services can be provided to an employee free of tax as long as payment is made directly to the service provider:

  • legal costs associated with a compromise arrangement.
  • Outplacement counseling.
  • Re-training.

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