termination payments tax free
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tax free redundancy pay
One of the most frequently asked questions in our line of work is are termination payments tax free? The short answer is: it depends.
Employment termination payments and their tax status are governed by tax legislation that quite frequently changes. You probably know that you can usually have tax free redundancy pay up to a limit of £30,000 (including any entitlement to statutory redundancy pay).
Otherwise taxation of termination payments can be complex depending on what the payments are being made for. For example, notice pay will never be paid tax free because it is an emolument from employment. Even if it’s paid in lieu of notice it will be taxed.
Tax on termination payments may arise in relation to benefits in kind that you are able to enjoy for a period of time after your employment terminates, a common example being ongoing private medical cover.
The tax treatment of termination payments will differ depending on whether you have issued a claim in the Employment Tribunals, whether you are being paid damages for personal injury or “injury to feelings” for a discrimination claim and so on.
“Injury to feelings” is the name given to damages for discrimination and has nothing to do with how injured your feelings are. Ultimately it will be determined by an Employment Tribunal if you go to trial. The level of injury to feelings compensation is dictated by the Vento guidelines and this will depend on the type of discrimination you have suffered, how long you have endured it, the damage it has done to your future career prospects or health, how serious the discrimination has been, etc. In most cases this is an amount of money between £900 and £18,000. The Vento guidelines are:
- lower band (for less serious cases): £900 to £9,000
- middle band (for those that do not merit an award in the upper band): £9,000 to £27,000
- upper band (for the most serious cases): £27,000 to £45,000 and
- with the most exceptional cases damages can exceed £45,000.
We can advise you clearly on the tax treatment of termination pay tax to ensure that you know when getting compensation roughly how much you will receive net in your bank. Making an additional payment into pension is a good way to reduce tax liability if the scheme rules permit it.
Payments that are made wholly on account of disability may qualify for full tax relief and be paid tax free under the provisions of section 406 of the Income Taxes (Pensions and Earnings) Act 2003. In some cases clearance will be sought from HRMC. In others the employer is comfortable assuming the tax risk and not deducting tax at source because the medical evidence is overwhelmingly supportive of the fact that you are unable to work because of disability. The HMRC guidance around this can be found online here:
We can assist with the clearance application process which must be supported by up to date medical evidence and which your employer will be required to submit on your behalf. If your employer refuses to make the application you may be able to reclaim the tax at self-assessment but this it not the usual process so you should be wary of relying on it.
We have deep experience advising around termination payments and taxation. We can guide and advise you.
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