The tax treatment of termination payments has changed significantly over recent years. The changes have aligned the rules for tax and secondary National Insurance contributions (employer (NICs)) by making an employer liable to pay NICs on termination payments they make to their employees.
Employees do not pay tax and National Insurance on:
- Contributions their employer makes to a registered pension scheme as part of their termination payment – tax will be due on any employer contributions that go above the Annual Allowance.
- Legal costs related to the settlement that their employer pays directly to their solicitor.
- A termination payment they receive because of an injury, illness or disability that prevents them from being able to continue to do their job.
Employees do not usually pay tax on the first combined £30,000 of:
- statutory redundancy pay;
- additional severance or enhanced redundancy payments your employer gives you; and
- non-cash benefits, for example company property you keep after your employment ends.
Employees are required to pay tax on any amount over a combined total of £30,000.
An employer is required to pay employer Class 1A NICs on any part of a termination payment that exceeds the £30,000 threshold.
Employees are liable to pay tax and National Insurance on payments they would have earned whilst working. This includes lump sum payments in lieu of notice (PILONs), pay on ‘gardening leave’ and part of any severance, enhanced redundancy or non-cash benefits they receive (known as Post-Employment Notice Pay (PENP).
Following a consultation that took place over the summer, the government confirmed that the £30,000 tax free exemption on termination payments would be retained. However, from April 2018 certain payments will no longer fall within the allowance.
It has been confirmed as part of the recent Autumn Statement that from April 2018 termination payments over £30,000, which are subject to Income Tax, will also be subject to employer NICs. Non-contractual termination payments of up to £30,000 will continue to remain exempt from Income Tax and employer NICs. The government will monitor this change and address any further manipulation of those making termination payments.
In addition, from April 2018, it will become irrelevant whether a payment made in lieu of notice is contractual or discretionary. These payments will be subject to deductions for tax and NICs as earnings. In addition, all other post-employment payments which would have been treated as general earnings if the employee had worked their notice period will be subject to tax and Class 1 NICs. These changes will have a direct cost for employers offering significant termination packages.