Termination Payments: What Employers and Employees Need to Know in 2024
Termination payments are a common feature of employment endings, especially during redundancy, restructuring, or negotiated exits.
But not all termination payments are tax-free—and with HMRC tightening enforcement, understanding what’s taxable and what’s exempt is essential for both employers and employees.
What Are Termination Payments?
Termination payments refer to any compensation paid to an employee when their contract ends. These may include:
- Statutory redundancy pay
- Payment in lieu of notice (PILON)
- Compensation for breach of contract
- Payments for restrictive covenants
- Ex gratia or goodwill payments
Each component is treated differently for tax purposes, and misclassification can lead to unexpected PAYE and National Insurance liabilities.
Tax-Free vs Taxable Termination Payments
Many assume that termination payments up to £30,000 are automatically tax-free.
However, this exemption only applies to non-contractual payments that don’t fall under general earnings.
The following are always taxable:
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PILON (if contractual or expected)
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Bonuses or commissions
-
Payments for restrictive covenants
-
Any contractual entitlements
Only the non-contractual portion of a termination payment may qualify for the £30,000 exemption.
Payment in Lieu of Notice (PILON)
Under current HMRC rules, PILON is treated as general earnings and taxed under PAYE—even if not explicitly stated in the employment contract. This applies whether the notice period is worked or not. The taxable portion is calculated using the Post-Employment Notice Pay (PENP) formula.
PENP Formula:
Where:
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BP = Basic pay before termination
-
D = Days between termination and end of notice period
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P = Days in last pay period
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T = Taxable earnings already paid (excluding holiday pay)
If PENP exceeds the total termination award, it is capped. Any remaining amount may fall under the £30,000 exemption.
Contractual vs Non-Contractual Termination Payments
When calculating tax liability, the first step is to identify whether the payment is contractual. If it is:
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It’s taxed under PAYE
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It counts as general earnings
-
It may attract National Insurance
If it’s non-contractual, such as damages for breach of contract or discretionary compensation, it may qualify for the £30,000 exemption and be NI-free.
Capital Gains and Termination Payments
Termination payments are not subject to Capital Gains Tax (CGT), but they may affect the employee’s overall tax position.
HMRC treats taxable termination payments as the top slice of income, which can push other income into higher tax bands.
How Trueman Brown Can Help
At Trueman Brown, we help employers and employees navigate the complex rules around termination payments. Whether you’re negotiating an exit package or managing redundancy, we offer:
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Tax-efficient structuring of termination payments
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PENP and PILON calculations
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PAYE and NI compliance
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HMRC reporting and dispute resolution
📧 Email: 📞 Call: 01708 397262
Let us help you avoid costly mistakes and ensure your termination payments are handled correctly.
FAQs: Termination Payments and Tax Rules
Q1: Are all termination payments tax-free up to £30,000?
No. Only non-contractual payments qualify. PILON, bonuses, and restrictive covenant payments are taxable.
Q2: What is PILON and how is it taxed?
PILON is payment in lieu of notice. It’s treated as general earnings and taxed under PAYE, even if not written into the contract.
Q3: How do I calculate the taxable portion of a termination payment?
Use the PENP formula to determine how much of the payment is taxable. The remainder may qualify for the £30,000 exemption.
Q4: Can damages for breach of contract be tax-free?
Yes. If genuinely non-contractual, damages may be tax-free up to £30,000 and exempt from National Insurance.
Q5: Do I need to report termination payments to HMRC?
Yes. Employers must report all taxable elements via PAYE, and employees must include relevant amounts in their Self Assessment if applicable.
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