You might know that the first £30,000 you get in a settlement agreement is typically free of tax and national insurance. (You might also know that settlement agreements are known as compromise agreements in Northern Ireland.) But you might not know that it all gets a teeny bit more complicated after April 2020. 
- If your compensation package includes Payment in Lieu of Notice (PILON), you now have to pay tax and national insurance on that element (this changed back in April 2018)
- If you are awarded compensation for injury to feelings caused by unlawful discrimination, up to £30,000 used to be tax-free – however it’s not any more (see below for details)
- If you receive more than £30,000, your employer will have to pay national insurance on the excess – that will cost them more and means they may change the amount they offer you (this applies after April 2020)
Injury to feelings: the back story
You might be wondering why the situation has changed with regard to injured feelings. Here’s what happened.
Mr Moorthy lost his job in 2010. He made a claim against his employer for age discrimination and unfair dismissal, and was awarded £200,000 in full and final settlement (that’s a legal term meaning there is no come-back after the payment is made).
At the time, “injury to an employee” was tax-free, and injured feelings counted as “injury”, just like physical and psychiatric injuries still do.
His employer took the case to the Court of Appeal, where they had to consider:
- Was the entire award taxable as income?
- How much (if any) of the award qualified as “injury to an employee”?
The court allocated £30,000 of the payment to cover Mr Moorthy’s injured feelings, so he didn’t have to pay tax on that amount – that’s the maximum it could be.
With that precedent in mind, other employees have since made claims where injured feelings were ‘rounded up’ to account for £30,000 of their compensation and reduce their tax bill.
However, since April 2018, injured feelings have NOT been treated the same way as psychiatric injury or personal injury – and that can make a difference to the way your claim is structured.
What this means to you
Although the rule change was intended to simplify things, as is often the case, it’s actually made things more complicated – which is why you should ask us for advice early in your negotiations.
We can provide full advice on making offers, or offers that have been made to you, and consider ways in which they can be framed to try and make them as tax efficient to you as possible.
Further reading
For more information on this subject, you might find our other articles useful:
- Is my settlement agreement tax-free?
- Do I have to pay tax on my settlement agreement?
- Are settlement agreements taxable?
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