How To Minimise Tax Payable On Redundancy/Termination Payments

Posted in Good Advice, Newsletter, Taxation

The economic impact of COVID 19 will be with us for some time, and as the jobs market deteriorates it is important for employers to apply the correct tax treatment to any redundancy or termination payments made to staff and similarly for employees to check that they have availed of all tax exemptions in relation to their redundancy/termination payment.

If you are unfortunately facing up to making some of your team redundant or if you have recently been made redundant or are facing the imminent loss of your job, it’s important to ensure that you know the most tax-efficient redundancy/termination package.

Statutory Redundancy

All employees are not eligible for a statutory redundancy payment.

The rules are:

  • An employee must have at least two years of continuous service with their current employer to qualify. Absences such as paternity, maternity, parental, adoptive, or carer’s leave do not break an employee’s length of service.
  • An employee’s position must be made redundant, as to qualify for payment an employee cannot just be dismissed.
  • An employee must also be paying Class A PRSI, unless you work part-time. (The  majority of workers pay Class A).

If employees meet the above requirements, employees can expect to receive at least a statutory redundancy payment, which is a tax-free lump-sum payment based on their pay.

All eligible employees are entitled to receive a statutory redundancy payment based on two weeks’ pay for every year of service plus a bonus week’s pay, subject to a maximum gross weekly earnings cap of €600 per week.

Examples : 

Maria who earns €1,000 gross per week with 10 years of service can expect to receive statutory redundancy lump sum of €12,600 from her employer i.e. (€1,000 weekly pay is capped at €600 per week) being €600 x 2 weeks x 10 years plus 1 week bonus of €600).

Mark who earns €500 gross per week with 10 years of service can expect to receive statutory redundancy lump sum of €10,500 from his employer i.e. (€500 per week (below €600 cap) being €500 x 2 weeks x 10 years plus 1 week bonus of €500) .

Ex Gratia Payments

Legally, an employer only needs to pay an employee their statutory redundancy payment if they are making an employee redundant.

However some employees may also receive an “extra” payment from their employer.

Employers may elect to make this additional payment where there is  an established custom and practice of making additional payments or if there is a union agreement in place regarding the payment of additional amounts to employees on termination of employment. These are known as ex gratia payments and the amount of payment tends to differ between businesses and industries.

The next two questions are two halves of the same coin –

How can an employer ensure that the  tax treatment of redundancy payments to employees has been treated correctly? And how can an employee ensure the tax treatment of their redundancy lump sum is correct and minimise the tax payable on any redundancy payment?

As before the statutory redundancy payment is tax-free. However, tax may be payable on any additional ex-gratia payment, subject to certain reliefs.

Options

It is best practice for employers to apply the correct tax treatment to employee payments including the highest exemptions possible to ensure employees receive the correct maximum net amount.

There are several options available so it is vital that all  the various options are calculated and documented to ensure the most tax efficient option is chosen.

To calculate the taxable amount, you can apply the higher of the basic exemption, the increased exemption or the standard capital superannuation benefit (SCSB).

Basic Exemption

The basic exemption exempts payments over and above statutory redundancy up to €10,160, plus €765 for each complete year of service from tax.

Increased Exemption

The basic tax-free exemption may be increased by €10,000 if the following two conditions are satisfied:

  • The employee has not in the previous ten years claimed an exemption greater than the basic exemption and
  • The employee is not a member of an occupational pension scheme or, if a member of a scheme, the employee has irrevocably given up the right to receive a lump sum from such a scheme.

If an employee receives or is entitled to receive a pension lump sum, part of the €10,000 may still be available. The amount so available is equal to €10,000 less the amount of the pension lump sum receivable.

If this is the best option for the employee in question and the employer applies only the basic exemption, the employee can at later date apply directly to Revenue for this option afterwards (normally when filing their end of year tax return) and get a refund from Revenue.

Standard Capital Superannuation Benefit

This benefit is most suited for employees with high earnings and long service as it is based on average annual earnings and the number of years of service.

In many cases the SCSB calculation will be the relevant amount and the decision an employee will have to make will be whether they waive or retain their right to their Pension Lump Sum (if applicable).

The maximum ex gratia lifetime termination payment which can be received tax free is €200,000.

Once the various different reliefs are calculated and the most efficient option is selected, any additional amount in excess of the chosen relief is liable to PAYE and USC. (PRSI does not apply to termination payments currently).

An employer is obliged to deduct PAYE and USC on all of the lump sum less the basic or increased exemption or SCSB as previously outlined. This means that the tax rate levied on the balance of the lump-sum payment could be 48 per cent.

It is worth noting that depending on when an employee is made redundant, they may be entitled to a partial refund on either the USC or PAYE paid. For example if an employee was made redundant early in the year and does not earn any more income for the rest of the year they may be eligible for a refund on tax paid.

If an employer is insolvent and is unable to meet the statutory redundancy obligations, the Department of Enterprise, Trade and Employment will fund payments directly from the Social Insurance Fund.

If you require advice on the redundancy/termination payment please contact us and we will be happy to advise you.

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