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Payoffs and the taxman

John Whiting
Tax Expert

John Whiting
John Whiting is Working Lunch's regular tax guru.

There is a general feeling that redundancy payments are tax free - or at least tax free up to a 30,000 limit. This bit of folk knowledge needs treating with care.

Here are 10 tax points to bear in mind about the payoff. A general tip is to clarify exactly the status of any payment that is being discussed before it is all settled so that you are clear as to the likely tax treatment - and hence its real value.

1. Payments that flow from the employment contract are taxable in full - these can include payments for gardening leave, finishing off projects or being available for work during the notice period and, importantly, "payments in lieu of notice" or "PILONs". PILONs occur where the employment contract allows the employer to make a payment rather than have the employee serve out a notice period.

2. Other payments - statutory redundancy monies, genuine payments for the loss of the job or "ex gratia" amounts that are not connected formally with the contract of employment can be income tax free up to 30,000 but are taxed as normal after that. This would also cover damages if the employer hasn't made a suitable payoff and the employee has sued for loss of employment.

3. Payments that qualify under the redundancy heading don't attract national insurance contributions (NICs) from employers or employees, whatever the amounts involved.

Your redundancy pay-off may not be tax free.

4. HM Revenue & Customs (HMRC) police payoffs carefully and contend that many 'redundancy' payments are actually contractual, and hence taxable in full. Another of their arguments is that a payment to someone who is at or approaching retirement age is an (unapproved) retirement benefit and taxable in full - so care needs to be taken that such a payoff really is for loss of job and nothing to do with retirement.

5. A payment for agreeing to do (or refrain from doing) something after the employment has ceased are normally caught for tax in full. That doesn't normally catch an agreement that a payment will be 'in full and final settlement' of any arguments around leaving.

6. Consider asking for some of a potential pay off to be paid into a pension scheme as additional employers contributions which are normally tax free, subject to overall limits.

A company car may eat into your tax free allowance too.

7. Continuing with benefits - e.g. continued use of the company car or simply being given the company car - will count as part of the pay-off (and hence can absorb more of the 30,000 exemption, if available). If the benefit continues into subsequent years, it can give 'income' (potentially taxable) in subsequent years.

8. There is no tax liability on amounts that employers pay for the employee's retraining, outplacement counselling or legal costs (paid direct to the lawyer) in connection with the termination.

9. There are a number of payments that can be made tax free, mainly relating to injury or disability; there are also exemptions where there has been extensive foreign service.

10. Timing-wise, payments are essentially taxable when the employee becomes entitled to them. This can mean that the employee is suddenly propelled into a higher tax rate thanks to the payoff. The idea of taking a payment in the next tax year (i.e. the tax year after employment has ceased) makes sense but it must be clear that that is when the entitlement arises - not just when the taxpayer has asked for the payment to end up.

John Whiting is a tax partner with PricewaterhouseCoopers LLP

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