Episode 9: Will I have to Pay Tax on my Settlement Payment?

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The Settlement Agreement Solicitor

Episode 9: Will I Have to Pay Tax on My Settlement Payment?

Hello, and welcome to The Settlement Agreement Solicitor Podcast. I am Geoffrey Caesar, a solicitor of England and Wales with over 20 years of experience specialising in settlement agreements.

Whether negotiating your first settlement or navigating a more complex situation, you are in the right place. In this episode, I am tackling one of the most common, and often most confusing, questions that come up when dealing with settlement agreements:

Will I have to pay tax on my settlement payment?

The answer is, it depends.

Let’s dive in and break it down into simple terms, while also digging into the legal nitty-gritty of UK tax law, which is where I step in as your trusted solicitor to guide you.

First things first, it is important to understand that not all payments you receive under a settlement agreement are treated the same way for tax purposes. Some will be taxable, and others may be entirely tax-free, up to a certain limit.

The £30,000 Tax-Free Allowance – What Is It?

Let’s start with the good news. Under UK tax law, certain payments made under a settlement agreement are tax-free up to £30,000. This is often referred to as the “£30,000 exemption.” But, we need to understand which payments qualify for this tax-free treatment.

Here’s the key distinction you need to keep in mind:

Payments that arise out of your employment contract are subject to tax and National Insurance contributions (NICs), just like your regular salary.
Payments made as compensation for the termination of your employment are potentially tax-free, up to £30,000.

Let’s explore that a bit further.

Contractual Payments – Taxable

Any payment that is owed to you under your employment contract is considered taxable. This includes things like:

Unpaid salary: Anything you’re owed up to your last day of work is treated as earnings.
Holiday pay: If you have accrued holiday that hasn’t been taken, this will be subject to tax and NICs.
Bonuses or commissions: If your contract entitles you to a bonus or commission payment, these are also fully taxable.
Payments in lieu of notice (PILON): If your employment contract includes a clause that allows your employer to pay you instead of having you work out your notice period, this too will be taxed like regular earnings.

In HMRC’s eyes, these are essentially payments for work done or for rights you have under your contract, and they’ll tax it accordingly.

Non-Contractual Payments – Potentially Tax-Free

Now, here’s where it gets interesting. If your employer is compensating you for the termination of your employment, that’s a non-contractual payment, and it may be tax-free up to £30,000. This is commonly referred to as a termination payment.

Here are a few examples of payments that could fall under this category:

Redundancy payments: Whether you’re getting a statutory redundancy payment or an enhanced redundancy payment, this can be tax-free up to the £30,000 limit.

Ex-gratia payments: These are payments made at your employer’s discretion, often as a gesture of goodwill or to help facilitate the settlement. As long as they are not owed to you under your contract, these, too, fall within the £30,000 tax-free limit.

Compensation for loss of employment: If your settlement agreement includes a lump sum to compensate for the loss of your job, this payment is not tied to your employment contract and can be tax-free up to £30,000.

When Payments Exceed the £30,000 Tax-Free Limit

So, what happens if your non-contractual termination payments exceed £30,000? Well, any amount over the £30,000 threshold is subject to income tax but not National Insurance contributions.

Let’s break that down with an example:

Imagine you’ve been offered a settlement payment of £50,000. Of that, £30,000 could be tax-free. The remaining £20,000, however, will be subject to income tax at your normal tax rate. So, if you’re in the 20% tax bracket, you’d pay £4,000 in tax on that excess.

What About PILON Payments Without a Contract Clause?

A quick word on Payments in Lieu of Notice (PILON): If your contract doesn’t include a PILON clause but your employer still chooses to make a payment instead of having you serve your notice, that payment used to benefit from more favourable tax treatment. However, since April 2018, these payments are taxable regardless of whether they are contractual or not. I will cover this in more detail in a separate episode.

Other Tax Considerations

Beyond income tax, there are a couple of other considerations. For example, some benefits in kind, such as continuing to receive your company car or health insurance, may be subject to tax. And in cases where compensation is being paid for injury or discrimination claims, those can sometimes qualify for more favourable tax treatment, depending on the nature of the claim. This is where professional legal advice really becomes crucial.

Why You Need Expert Guidance

Navigating these tax rules can be tricky. Understanding the difference between taxable and non-taxable payments under a settlement agreement is not always straightforward, and the last thing you want is a surprise tax bill after you’ve already signed on the dotted line. That’s why it’s so important to have a solicitor with experience in settlement agreements review the terms and advise you on how to minimise your tax liability while maximising your financial compensation.

As The Settlement Agreement Solicitor, I specialise in these agreements. With over 20 years of experience, I can help you understand the terms and, most importantly, ensure you’re not paying more tax than you need to.

If you’ve received a settlement agreement or think you might soon, give me a call or visit my website at settlementsolicitor.uk for a no-obligation consultation. I’ll help you understand your rights, navigate the tax maze, and ensure you get the best outcome possible.

Thank-you for listening to The Settlement Agreement Solicitor Podcast. Don’t forget to subscribe and leave a review.

And remember: when it comes to settlement agreements, expert advice is priceless.

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