We are often asked, ‘Is tax payable on settlement agreement compensation?’
Our solicitors are experts in Settlement Agreements and assist employers and employees nationwide. We have our very own specialist Settlement Agreements website which although aimed at employees contains a great deal of information relevant to employers. If you require advice on entering into a Settlement Agreement with an employee or would like us to draft a Settlement Agreement for you then give us a call or send an email to [email protected]
The £30,000 tax exemption
A Settlement Agreement allows an employee to waive their rights to bring a claim and in return receive a sum of compensation. In this way compensation of up to £30,000 paid under a Settlement Agreement can be tax free.
However, care needs to be taken because not all payments made under a Settlement Agreement are free of tax.
It is therefore very important that the solicitors preparing the Settlement Agreement make it crystal clear how the payment to the departing employee is calculated, distinguishing between those elements that are taxable and those which are non taxable.
What does the £30,000 tax free limit apply to?
The £30,000 tax free limit applies to compensation and redundancy payments.
Although legal costs are not taxable they do not count towards the £30,000 exemption, as long as they relate to the termination of the employment contract and are directly paid to the employee’s solicitors under the terms of the Settlement Agreement.
What payments are not included in the tax free limit?
It is important for employers to recognise that some payments made to employees under a Settlement Agreement will not be tax free. These include payments in respect of salary and employment benefits that have already accrued, payments in lieu of notice or holiday, payment for injury to feelings occurring after termination and payments made in respect of restrictive covenants or non disclosure agreements.