The short answer is that you will need to pay tax on some of the payments made under a settlement agreement but you will not need to pay tax on certain sums.
You will normally need to pay tax on the following sums:
- Your notice pay (whether you’re being paid in lieu for your notice pay, you work your notice out, or you’re placed on garden leave);
- Holiday pay;
- Bonus payments; and
- Any other payments that you’re contractually owed by your employer
You will not normally have to pay tax (or National Insurance contributions) on payments made as compensation for the termination of your employment (also known as ‘ex-gratia payments’) up to a total sum of £30,000. Any compensation paid over £30,000 will normally be subject to tax (but not National Insurance).
Payments made as compensation for injury to feelings are generally also not taxable (if the injury to your feelings relates to a detriment that you suffered prior to your dismissal).
Equally, payments made on account of a disability are also normally free of tax and national insurance.