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Will the termination payment in my settlement agreement be taxed?

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Settlement agreements are commonly used to settle or waive any employment related claims an employee or worker may have against an employer. Our Employment team specialise in advising employees and workers on their rights regarding settlement agreements, and are regularly asked whether the payment they receive will be taxed.  Here, the team answer this question, as well as advise on the next steps should you be presented with a settlement agreement. 

What is a settlement agreement?

A settlement agreement is ordinarily used on termination of employment but can also be used during employment; in exchange for giving up your rights to bring a claim against your employer, you will receive a termination payment which may include payment in lieu of notice or a redundancy payment.  

Different payments under a settlement agreement will afford different rules with regard to tax. Anything which is paid to you as settlement for a contractual sum will be subject to deductions for tax and National Insurance in the usual way as if it were income. This will cover payments such as a full contractual notice period payment or a payment for outstanding accrued, but untaken, holiday.

Any payment which is non contractual and represents a compensation payment for loss of employment or compensation for a claim will be tax free in accordance with sections 401 to 404A Income Tax (Earnings and Pensions) Act 2003. These sections outline that only the first £30,000 of such payments will benefit from being tax free. This also includes ex gratia payments and any payments representing a statutory redundancy payment.

If any termination payment is paid over and above £30,000 then this will be subject to tax in the normal way based on your relevant tax code. Currently, all that is payable is tax for the sums over the £30,000 limit. The government has however proposed changes to this rule, which state that from April 2020 any termination payment which is in excess of £30,000 will be subject to tax and National Insurance contributions. 

What should I do if I have been asked to sign a settlement agreement?

In this situation, you must receive legal advice otherwise the settlement agreement will not be legally binding.  Employers will usually contribute towards your legal fees to receive this advice, normally up to £250.  By having this meeting with us, you will also benefit by having a better understanding of your rights and any potential tribunal claims that you are waiving upon signing the agreement.  

We can not only offer you this advice, but if you decide not to accept the terms of the settlement agreement, we can negotiate on your behalf with your employer.  We will of course review this depending on your own personal situation and advise whether this may or may not be prudent.

If you have been offered a settlement agreement by your employer, you can contact us today for tailored, professional and pragmatic advice on 023 8071 7717 or email employment@warnergoodman.co.uk.

ENDS

This is for information purposes only and is no substitute for, and should not be interpreted as, legal advice.  All content was correct at the time of publishing and we cannot be held responsible for any changes that may invalidate this article.