Are Settlement Agreement Payments Taxable?

Settlement agreement payments usually come in the form of a one-off payment that consists of a termination payment (lump sum).

However, there are many different payments an employee can receive with their settlement agreement. 

Not all payments will be taxable but some will be and it’s important to understand which are.

A qualified and experienced employment solicitor can provide legal advice relating to your settlement agreement.

Contractual payments can include:

  • Pension
  • Paid holiday
  • Pay in lieu of notice
  • Owed salary and any bonuses

In most cases, an initial termination payment of £30,000 as settlement agreement compensation, can be paid to an employee without being eligible for tax. This amount is only considered as  tax exempt if no contractual payments are included.

Below are some of the different payments typically included within a settlement agreement as well as their tax implications.

Compensation payments over the £30,000 exemption threshold

Any compensation amount that exceeds the £30,000 threshold will be subject to a basic rate of tax.

In lieu of holiday payment

Most employees will have accrued holiday up until the termination of their employment. Payment for left over holiday will be taxable.

Payment for redundancy

Most redundancy payments either contractual or statutory fall into the £30,000 compensation that can be paid to an employee tax free.

Costs for legal services and advice

With regards to the act of processing and signing a settlement agreement, a solicitor’s legal fees will be covered by the employer. Any termination of employment fees are paid directly to the solicitor. These fees are covered by clauses relating to a settlement agreement.

Pension scheme contributions

Standard pension scheme contributions are classed as being separate and not liable for any tax deductions. Pension scheme contributions fall under specific annual allowances, payments exceeding this allowance will be liable for tax.

Ex-gratia payments

Non-contractual or ex-gratia compensation amounts are not liable for tax under the £30,000 threshold.

Pilon

NI and tax deductions are usually a requirement on most payments in lieu of notice but it really depends on the employment contract’s terms. 

HMRC may require further tax to be paid where gross payments have been incorrectly made and further tax claims made to the employer by HMRC will be passed onto the employee. Most settlement agreements include an indemnity clause stating that your employer will not be eligible for any further tax contributions sought by HMRC at a later date.

Injury or disability payments

Injury and disability payments will not be eligible for tax as long as the payment is in relation to the injury and not based on loss of earnings arising from the injury. Injury to feelings payments related to unlawful discrimination that happened before the termination of employment would not be eligible for tax.

Need help with your settlement agreement?

In some cases, legal fees can amount to more than the fee contribution made by an employer.

In a situation such as this, an employment lawyer can liaise with your employer and request the excess costs be covered by them.

An experienced legal professional will be able to advise you on any tax payment amounts as well as when they need to be paid. Although we can advise on what payments are tax eligible, HMRC will ultimately dictate what tax payments you’re eligible to pay and when.