TAX TREATMENT OF TERMINATION PAYMENTS

Are you AN EMPLOYEE leaving your current employment? Are you in receipt of a lump sum from your employer? Or are you AN EMPLOYER making a termination payment to a staff member or a group of staff?  Do you know how to process these payments correctly through your payroll and avoid costly mistakes?  Are you aware of the appropriate tax treatment of same?

The calculations of the exemptions and reliefs relating to termination payments can be complex and detailed.  We can guide you through the options and help you structure any termination payments in an efficient manner helping to minimise the tax cost.

A contract of employment can be terminated legally in a number ways by agreement, by dismissal, by repudiation or by frustration and in these circumstances a payment on termination may be payable to an employee.

To keep it simple….a certain amount of an employees’ termination /redundancy payment may be paid tax free and the balance may be taxed (as part of the current year’s income).

There are different options/reliefs available under the Revenue’s rules for the tax treatment of the taxable balance. You get to choose between different reliefs as to what best suits you and your circumstances.  These different calculations should be performed to ensure that you elect for the relief that minimises your tax cost.

Basically:

  • Payment in lieu of notice is normally taxable.
  • Statutory redundancy is tax free.

(Statutory redundancy is the amount an employee is legally entitled to receive on cessation of employment under employment legislation. To qualify, the employee must be making PRSI contributions under the A class and

have worked continuously for the employer for at least two years.)

  • A non-statutory/ex- gratia redundancy payment is normally taxable. Ex gratia is the amount of payment that may be made by an employer to an employee that is over and above the statutory redundancy entitlement. The main part of this article deals with the tax treatment of ex gratia payments.

Statutory Redundancy is determined by the employee’s length of continuous service and weekly earnings. The weekly earnings include gross weekly wages and benefits in kind. Currently the maximum weekly amount for a statutory redundancy payment is €600. Any excess above the €600 weekly limit is disregarded for the purposes of the statutory redundancy calculation.  If an employee is eligible for a redundancy payment, they are entitled to two weeks’ pay for each year of service and a bonus weeks’ pay based on their entire period of service. You can calculate your statutory redundancy entitlement under the welfare.ie website (www.welfare.ie/RedundancyCalculator).

Ex gratia is the amount of a payment that may be made by an employer to an employee that is over and above the statutory redundancy entitlement.  Ex gratia payments are discretionary or may be negotiated between employers and employees. When calculating the tax and USC due on ex gratia payments, you are entitled to avail of any one of the following tax reliefs. It is worthwhile investigating which option is the best for you; it will take a little time but may save you thousands…..

You can choose from the following options in respect of the tax treatment of your ex gratia lump sum:

  • Basic Exemption
  • Basic Exemption plus Increased Exemption
  • Standard Capital Superannuation Benefit (SCSB)

Realistically you will only be in position to choose the best option for you once all the calculations have been prepared and completed. Each calculation will give you a different result and tax cost.

PAYE & USC are normally due on the taxable part of a lump sum termination payment but there is no PRSI liability.

  1. Basic Exemption

The Basic Exemption allows you to receive an additional €10,160, plus €765 for each complete year of service, tax free.

  1. Basic Exemption plus Increased Exemption

On top of the Basic Exemption, a further €10,000 (called the Increased Exemption) is also available if you haven’t received a tax-free lump sum in the last 10 years and you are not getting a lump sum pension payment now or in the future.

(If you are in an occupational pension scheme, the Increased Exemption can be reduced by any tax-free lump sum from the pension scheme you may be entitled to receive.)

  1. Standard Capital Superannuation Benefit (SCSB)

SCSB is another possible relief that normally benefits people with higher earnings and long service.  It is capped at €200,000.

It can be used if the following formula gives an amount greater than any of the above reliefs.

Formula for SCSB: Take the average annual earnings over the previous 3 years (or the whole period of service, if less than 3 years), multiply this figure by the number of years’ service; divide by 15. (In addition again if you are in an occupational pension scheme, the SCSB can be reduced by any tax-free lump sum from the pension scheme you may be entitled to receive).

 

As is clear from the above, the calculations of the exemptions and reliefs as they apply to ex gratia lump sum termination payments can be both complex and detailed.  Employers and employees need time to carry out the calculations, to consider and review the results, to consult with their advisors before making the correct and optimum choice. We can guide you through the process and help structure any termination payments to minimise the tax cost.

(The above advice does not deal with the tax treatment of your pension scheme lump sum or payments made on account of injury or disability or payments arising from employment law rights claims).

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