Redundancy

The tax implications of redundancy can be complex, even though the basic rules sound quite simple.

Basic rules

Employees can receive up to £30,000 as a ‘qualifying termination payment’ free of tax and National insurance. This amount includes any statutory redundancy pay to which you are entitled. If you receive more than £30,000, then the extra amounts over the £30,000 limit are taxable.

Some payments which are made when someone is made redundant are always taxable. These include amounts which are paid under a contact of employment such holiday pay, bonuses, and arrears of pay.

Payments in lieu of notice may be taxable or not. The exact position depends on a range of factors that will include the employee’s contract of employment, when notice of redundancy was given and how the pay in lieu of notice has been calculated.

If you are leaving employment through ill health, you may be able claim additional relief in excess of £30,000 but there are strict tests that must be met.

A general factsheet, suitable for employees facing redundancy is available on the HMRC website at http://www.hmrc.gov.uk/guidance/redundancy-factsheet.pdf

Tax credits

For tax credits, the income to be declared is the same as taxable pay for income tax. So tax free redundancy amounts up to £30,000 can be ignored.

Possible complications

There are two main areas of difficulty:

1)      Is a particular payment taxable? The tax status of some payments made at the time of redundancy may be difficult to establish. This is true of, for example, pay in lieu of notice. Pay in lieu of notice is often taxable, but not always. This is a complex area and you may want to take advice from HMRC or a tax adviser (see other sources of advice). If you are on low income you may wish to contact TaxAid

2)      Have I paid the right amount of tax? There are two potential difficulties here:

1. Underpayment of tax where someone has received more than £30,000 in redundancy payments
2. Overpayment of tax – this is likely where someone is made redundant early in the tax year and does not find another job within the tax year

a) Underpayment of tax

If an employee is made redundant and receives redundancy payments in excess of the £30,000 tax free limit, the employer should notify HM Revenue and Customs.

HMRC should then notify the employee that it is possible that additional tax may be due and that a self-assessment tax return may be issued at the end of the tax year to collect any additional tax due.

Sometimes things go wrong and the employee is not informed of a possible tax bill at the time the redundancy money is received. HMRC may become aware later that there is a problem and send out a return, but by this stage, the employee has spent the money, or used it to pay off loans.

The additional bill happens, because tax may have been deducted from the redundancy pay at only basic rate (20%), but, taking all income for the year into account, the individual’s total income may be high enough to mean that they are liable to pay tax at a 40% or more on some of their income.

b) Overpayment of tax

Many employees – particularly those who do not find other work and were made redundant early in the tax year – may be due tax refunds. If the former employee claims benefits, then any refund will be administered via the jobcentre: otherwise it may be necessary to apply for a refund on form P50 http://www.hmrc.gov.uk/pdfs/p50.pdf.