Most Important Facts about Settlement Agreement tax Implications

If you have recently negotiated a settlement agreement that involves payment, you may be wondering what the tax implications are regarding the payment and how this can impact the final settlement agreement you decide upon with your employer.  

Are monies paid under a settlement agreement subject to tax? 

Such as with your salary, some settlement agreement payments are liable to taxations, whereas some can be paid tax-free. 

We have put together the below factsheet, which is split into three sections, to explain the different areas of settlement agreement tax to provide you with all the information you need. 

1. TAXABLE PAYMENTS 

Payments that will attract tax which can be paid under a settlement agreement are as follows:   

Payment of salary up until leaving date 

The payments of your salary and benefits that are normally paid, which are paid under a settlement agreement up to your termination date to you will be liable for the usual taxations and National Insurance payments.  

Payment for holidays owed but not taken ahead of employment termination 

Should you have any accumulated holiday that you have not used before your employment terminates, your employer should pay you for these days.  

This payment is taxable in the usual way. 

Payments for restrictive covenants added to the settlement agreement 

These terms can be found in your contract of employment and can also be carried over to your settlement agreement.  

In some instances, an employer may wish to revise or add to these covenants in relation to your settlement agreement or insert new restrictions. Separate consideration should be provided for if new covenants are being entered into. If a separate sum is not specified in respect of these then the HMRC may argue that any termination payment paid free from tax should be taxable in full. 

While the sums paid to you may be relatively small, they are still subject to income tax, as well as National Insurance payments.  

Pay in lieu of notice (PILON) 

If you did not work all or part of your notice, your employer must still account to HMRC for any basic pay that you would have received should you have worked it. Post-employment notice pay, or PENP, refers to the basic pay that is equivalent to any notice period that is unworked and is calculated using a specific formula. 

Once again, this basic pay is treated as regular earnings and is therefore subject to tax and National Insurance payments. 

Post-employment notice pay (PENP) 

2. EX-GRATIA PAYMENTS 

Are ex-gratia payments taxable? 

Ex-gratia, termination payments, or goodwill payments under £30,000 are not subject to tax, however, should they exceed this amount, anything exceeding the £30,000 will be liable for taxation. 

Find out more about settlement agreement tax 

There is no legal requirement to state the taxation of payments in a settlement agreement but it is helpful if it is.  

Usually, there will be a tax indemnity clause in a settlement agreement which provides that the employee will be liable for any further tax due if it is queried by the HMRC so it is important that it is right for the employee.  

If you have further queries surrounding settlement agreement tax, you can get in touch with our team of employment solicitors, who can provide expert guidance and ensure you have the information you need. 

Get in touch with our dedicated team of settlement agreement employment solicitors either by emailing sa@smithpartnership.co.uk, or calling us at 08000 32 32 02 today.