Is my settlement agreement tax-free? - Paul Doran Law

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Is my settlement agreement tax-free?

Unfortunately, there isn’t a simple answer to that question, but here’s a brief overview to give you an idea.

Taxable income payments

If your settlement agreement* includes a sum to cover salary, bonus, commission and holiday pay that’s due to you, you will have to pay tax and national insurance at your usual rate.

If your employer pays for your company car, healthcare or other ‘benefits in kind’, they are taxed in the usual way.

If you work your notice period, the amount you earn will be taxed as usual. If you receive payment in lieu of notice (PILON), that amount is also taxable. (The law changed in April 2018 to include *all* PILON payments).

If your agreement includes an additional payment in return for you accepting a new or updated restrictive covenant, this amount also counts as earnings and is taxed in the usual way. (A restrictive covenant is where you are restricted from working in the same sector or with the same people for a period of time).

Tax-free income payments

If you have been made redundant, and your employer is paying you a sum of money in return for losing your job, the first £30,000 is tax-free. (You might be interested to know this has been set at the same level since 1988.)

Is your employer paying towards your pension or retirement scheme as part of the agreement? If yes, it’s not taxable.

It depends…

If you have been awarded compensation because of wrongful dismissal, unfair dismissal or discrimination, it may or may not be taxable depending on the circumstances.

The situation is even more complex if you are offered a cash payment for shares you owned in the company. If you sell your shares as part of the settlement, you may have to pay capital gains tax (unless you’re exempt).

What this means to you

It’s your employer’s responsibility to deduct the appropriate tax and national insurance under PAYE, so the payment you receive will be net.

Watch out in case your employer includes a ‘tax indemnity’ in your agreement. This means you will be liable if HMRC decide that further tax is due. If the amount paid is wrong, interest and penalties become due.

When your employer offers you a settlement agreement, you want to be sure it’s structured in a way that gives you the maximum tax relief. We can help with that.

*By the way, if you’re in Northern Ireland, settlement agreements are known as compromise agreements.

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