Taxation of Redundancy Payments
Redundancy is a situation where an employer needs to reduce the size of their work force. When someone loses their job as a result of redundancy, the taxation of the amount they receive for this will be dependent on a number of factors. It should be noted that redundancy payments do not have to solely be in cash. If you receive a benefit as part of your redundancy, such as being allowed to keep a company car, the cash value of that benefit will be taken into account in any subsequent calculations.
What is taxed?
The first £30,000 of a redundancy payment is exempt from tax, with any excess taxable as normal. However, this only applies to payments that are solely for redundancy itself. It is possible that an employee will be due additional amounts that do not qualify for this. This includes payments for accrued holiday not taken or payments in lieu of notice (PILON – an amount paid because you have not been given notice of your job ending, equivalent to the wages for the period of notice not given). Any payments like these arising directly from an employment contract will be subject to tax and national insurance as normal wages income.
With regards to PILONs, there has been a change in the rules from 6th April 2018. Before this date, if the right to receive this was not included in the employment contract, then it was treated as a redundancy payment. Now a PILON is treated as taxable income in all cases. It is therefore even more important to accurately determine how a redundancy package is made up.
The employer will be held liable by HMRC for any failure to deduct tax and National Insurance when it is due. Accordingly, some will apply it to all payments to avoid the risk of such a failure. Where there is uncertainty on the correct treatment, both sides should take appropriate advice.
How is it taxed?
Any amounts due to be taxed regardless, plus any redundancy amount above £30,000, will be taxed as wages. If payment is made before issuing form P45, then this will be calculated based on your wages to date, including any taxable amounts on redundancy, in the current tax year. If payment is made after issuing form P45, then calculations will be made solely for the amount paid using a 0T tax code instead.
Will tax be overpaid? If so, how do I get the overpayment back?
Whether tax is overpaid will be dependent on a number of factors. The two largest factors are how early in the tax year you have been made redundant and whether payment has been made after the P45 was issued. As your tax-free personal allowance is spread over the tax year under PAYE, being made redundant earlier means less of it has been used in calculations generally. For the late payment, the use of a 0T code means none of your tax-free personal allowance is taken into account for that payment. Both these are likely to result in overpaid tax. How you get overpaid tax back will depend on what you do next
If you go into employment, then the figures on your P45 become part of the calculations for your new employer. This means that any tax overpaid on your P45 will end up getting repaid through your wages over the remaining months of the tax year. Any overpayment on a post-P45 payment should be dealt with automatically at the end of the tax year.
If you claim Jobseeker’s Allowance or Universal Credit, then you would give parts 2 and 3 of your P45 to the Jobcentre instead. They will then determine if you are due a refund either when your claim ceases, or when the tax year ends, whichever is earliest.
If you go into self-employment, or have other income requiring a tax return, then you can claim through your return. When completing the return, remember that the first £30,000 of redundancy is exempt from tax and should not be included in your employment income figures.
If you are not doing any of the above, you can make a claim within the tax year using form P50. (tinyurl.com/n849glt). This can be done once you have been unemployed for four weeks, and you have no intention of continuing to work. You will need to provide HMRC with parts 2 and 3 of your P45 as part of this claim. Alternatively, if you are leaving the country entirely, you can complete form P85 instead. (tinyurl.com/pehgmnp)
Whilst ensuring that you get full benefit from the £30,000 redundancy exemption is important, there is one other way tax can be minimised. Payments made into a pension scheme as part of a redundancy settlement are fully exempt from tax. Such payments must be made direct to the pension scheme. Individual pension schemes will have their own limits on such contributions, and they may have other requirements to be met. It is therefore important that you contact your pension provider as soon as possible if you are considering this option.
It is also possible to reduce your tax bill by making contributions to your personal pension scheme yourself from your redundancy pay. The annual allowance for such contributions is £40,000, though you may have unused allowances from previous years as well. Obviously, whilst such contributions will reduce your tax, they do mean the money is locked up in your pension scheme. You therefore need to carefully consider if you need the funds available before doing this.
We hope you have enjoyed reading this article. The future of our volunteer led, non-profit publication would be far more secure with the aid of a small donation. It only takes a minute and we would be very grateful.