The figure on the front page of your settlement agreement is not necessarily the figure that will land in your bank account. How your package is structured for tax can make a difference of thousands of pounds, and it is one of the most common areas where employees lose out.
The £30,000 Rule
The headline rule is straightforward. The first £30,000 of a genuine compensation payment for loss of employment can usually be paid free of income tax and National Insurance. Anything above £30,000 is taxed as income.
The complication is deciding what counts as genuine compensation. Get the labels wrong and HMRC may treat payments as taxable earnings, leaving you with an unexpected bill.
What Is Always Taxable
Some parts of your package are taxed as normal earnings no matter how they are described. These include your notice pay or payment in lieu of notice, accrued holiday pay, and any bonus or commission you have already earned. Since 2018, employers must also tax an amount known as post-employment notice pay, which broadly reflects the notice period you did not work.
Areas That Need Careful Handling
Payments into your pension can often be made gross, which is highly tax efficient. Injury to feelings payments, legal fee contributions and outplacement support each have their own rules. Watch out too for tax indemnity clauses, which are standard but mean you carry the risk if HMRC later challenges the treatment. All the more reason to get the structure right first time.
Structure Matters As Much As Size
Two identical headline figures can produce very different take-home amounts depending on how they are allocated. When we review your agreement, we check the tax treatment of every payment and negotiate a structure that works in your favour.
We also make sure the agreement records the allocation clearly in writing, so there is no ambiguity later if HMRC ever asks questions.
Get The Full Picture Before You Sign
With 35+ years of employment law experience, we explain the tax position in plain English and make sure nothing is left to chance. Same day reviews, no hidden fees, and your employer pays all costs. Get your free review today.
