Is my severance pay taxable? Can I pay less tax on it? Is my redundancy package structured in the most tax-efficient way? We regularly advise employees and employers on the legal aspects of settlement agreements. Naturally, employees are keen to know how much they will receive after any deductions for income tax and National Insurance contributions (NICs) have been applied. Businesses also want to work out the total cost of the package, for example when employer’s NICs are added on. The government is making some changes to the rules in this area with effect from 6th April 2018. Whilst we are not tax advisers and specialist advice may be required in this area, here is a summary of the changes.

Payments in lieu of notice

At present, employees (and employers) may benefit from a rule which can mean payments in lieu of notice are paid without deductions for income tax and NICs. Where the employer has no express or implied contractual right to make a payment in lieu of notice, it may be possible for the notice pay to be paid gross up to a maximum of £30,000, as it can be treated as damages or compensation for breach of contract. As an example, let’s say an employee is paid £5,000 per month (£60,000 per year) and she is entitled to one month’s notice of termination. If any payment in lieu of notice can be paid without deductions she gets the full £5,000 (instead of losing about £1,500 to tax and NICs) and the employer saves a small amount in employer’s NICs. Both sides are (usually) happy.

From 6th April 2018 all payments in lieu of notice will be subject to income tax and NICs – meaning the savings in the above example will no longer be available to the parties.

Payment for injury to feelings

Compensation for injury to feelings – such as those awarded where there has been unlawful discrimination because of a protected characteristic such as race or gender – will fall outside the tax exemption for injury payments, except where the injury amounts to a psychiatric injury or any other recognised medical condition.

Foreign Service Relief

Under the current rules, UK resident employees who have worked for a part of their career outside the UK can claim relief from income tax on their termination payments. From 6th April 2018 this will no longer be available.

Looking ahead to 6th April 2019

As referenced above, there is a £30,000 limit on the aggregate amount an employee can receive tax free as part of their termination package. Above that limit, income tax is payable – but no NICs – unless both income tax and NICs are payable for some other reason, such as the amount is earnings from employment or, under the new regime from April 2018, any payment in lieu of notice. This is going to change from 6th April 2019. After that point termination payments will be subject to income tax and employer’s NICs in respect of the amount which exceeds £30,000. Employees will still benefit from no employee’s NICs on the amounts above £30,000.


If you are thinking of offering a severance package to an employee or you are an employee and thinking of asking for one, now might be a good time to explore that possibility. Once the rules change, employees may be entitled to less money after statutory deductions and severance packages may cost more for employers. The cost for employers offering substantial packages will increase again in a year’s time. If you would like to discuss redundancy, settlement agreements (or compromise agreements as they used to be known), please call one of our specialist employment solicitors for a free initial chat.