Settlement agreements can be offered for a variety of reasons. There could have been a workplace dispute, or an employer may have been looking to facilitate a redundancy process. Regardless of the circumstances, individuals should understand settlement agreement tax laws and thresholds to ascertain how much of their compensation will be paid tax free. 

Below, we address common questions surrounding this issue, clarifying which elements of such agreements are taxable and which are exempt. If you have any queries or have recently received a settlement agreement and want legal assistance, please do not hesitate to reach out.

Settlement Agreement Lawyers are employment law specialists, and with our years of experience, we can provide expert guidance and answer your questions. To get started with us today, simply:

• Call us at 0800 464 7254
• Request a callback by filling out our online contact form

What Sums Can be Paid Under a Settlement Agreement Tax Free?

In the UK, specific sums can be paid under a settlement agreement tax free. In most cases, the first £30,000 of compensation is exempt from tax, with any amount exceeding this threshold subject to taxation. However, while sums over £30,000 are taxable, they aren’t subject to employee National Insurance Contributions.

When multiple payments have been made, the figures will be combined to determine whether the total sum exceeds the established limit. Payments that may fall under this category include:

• Compensation for the termination of employment: Payments made directly related to the end of an employment contract.
• Ex-gratia payments: Voluntary sums provided by an employer, not required by law or contract, often given as a gesture of goodwill.
• Compensation for injury to feelings: Payments awarded in specific cases, which may be exempt from tax if the incident occurred before the termination of employment.

Depending on the relevant factors, additional payments may be made under a settlement agreement tax free; only these come without a limit. Such payments could cover registered pension scheme contributions, legal costs, a sustained injury or disability or outplacement.

Similarly, sums paid upon death or due to departure because of disability or injury may have an unlimited tax-free status. However, caution must be exercised in such circumstances, as said status will hinge on the specifics of each given situation.

If an individual is unsure whether their settlement agreement is tax free, it’s advisable they seek guidance. In the first instance, they could bring their queries to their company’s HR or payroll team. Should any questions remain, they may then want to seek assistance from HMRC, an accountant, or an employment solicitor.

When Are Sums Under a Settlement Agreement Taxable?

With various payments exempt from tax, individuals might wonder, “Is a settlement agreement taxable at all?”. The answer is yes. Regular income, such as wages, employee benefits, and holiday pay, would typically face tax and National Insurance Contributions deductions as normal.

Individuals uncertain about their standard earnings should consult their employment contract to gain a clearer understanding. This will offer detailed insights into their contractual entitlements and help clarify which aspects of their settlement agreement may be tax free.

Settlement Agreement Tax: How Much Should You Pay?

Without knowing the specific details of a case, it’s difficult to accurately determine the tax liability. The total compensation offered, how much of it qualifies to be paid under the settlement agreement tax free, and an individual’s regular income will largely determine the taxable amount.

Once the compensation has been received, individuals should review their final payslips, carefully examining the amounts paid and taxes deducted. It’s advisable to consult with a qualified professional, such as a member of payroll, employment lawyer, or accountant, to discuss the details further and ensure everything has been processed correctly.

Is a Redundancy Payment Taxable?

To avoid the time-consuming nature of a redundancy process, employers may opt to use a settlement agreement when making an employee redundant. In such circumstances, they might offer a statutory redundancy payment, the minimum legally required, or an enhanced contractual figure.

Regardless of the amount, the redundancy payment would fall under the £30,000 threshold along with any other qualifying payments. Any sum exceeding this threshold will be subject to tax.

Is Notice Pay Taxable?

Notice pay is taxable under UK employment law, regardless of whether it’s included as part of a settlement agreement or paid separately. This encompasses both Payment in Lieu of Notice (PILON) and Post-Employment Notice Pay (PENP).

Similar to regular income, notice pay doesn’t benefit from a tax-free allowance; therefore, income tax and National Insurance Contributions would be deducted. This taxation arises because notice pay is effectively remuneration that an employee would have received had they fulfilled their notice period. Since wages are subject to tax, so too is notice pay.

Settlement Agreement Tax: Are Wages Paid Under a Settlement Agreement Taxable?

As previously mentioned, regular income does not qualify as a settlement agreement tax free payment. Since wages are considered part of that income, they are subject to taxation.

How Can Settlement Agreement Lawyers Help You?

If you have any questions about whether your settlement agreement is tax free, it’s advisable to seek expert advice. Employment law and taxation can be intricate subjects, and having a specialist by your side can significantly simplify the process. Often, a good starting point is to consult your HR department or a member of the payroll team, as they can provide insight into your specific situation.

However, if consulting in-house isn’t feasible, or if you still have lingering questions, you may want to consider reaching out to HMRC, a tax specialist, or an employment lawyer. Should you want assistance from the latter, please do not hesitate to contact Settlement Agreement Lawyers.

We have successfully helped numerous employees navigate their employment issues, equipping us with the expertise needed to resolve your case effectively. Initially, we would conduct a brief call to assess your situation and address any immediate concerns you may have. Following that, we could discuss a tailored plan for moving forward.

If you’re interested in learning more about the support we offer, please:

• Call us at 0800 464 7254
• Complete our online form to request a callback