Employee tax codes and National Insurance
The tax implications of redundancy can be complex, even though the basic rules sound quite simple.
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.
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.
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. If you are on low income you may wish to contact TaxAid. To check advice options, see who can TaxAid help .
2) Have I paid the right amount of tax? There are two potential difficulties here:
a) Underpayment of tax where you have received more than £30,000 in redundancy payments
b) Overpayment of tax – this is likely where you are made redundant early in the tax year and do 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. 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 too low a rate. 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 higher rate on some of their income. The tax code 0T Month 1 should be used by employers for one-off redundancy payment. This reduces the risk of large tax underpayments.
How this happens
Employees are often paid a lump sum after they have left the payroll. When this happens, a PAYE of 0T should be used on a Month 1 basis. The 0T month code gives no tax free pay and only one month’s allocation of each tax band. So for 2016-17 tax will be due after £2,667 of income (2015-16 – £2,648), that is one twelfth of the £32,000 basic rate band.
For most employees this should ensure that sufficient tax is paid, but it is unlikely to be exactly the right amount – taking account of any other income for the year. Hence, if someone is a basic rate taxpayer, taking account of the whole year, then they are likely to overpay tax on a redundancy lump sum of more than £32,667 (£30,000 tax free, plus £2,667 at 20%).
Whereas if they are a higher or additional rate taxpayer over the whole year, then they may underpay tax on any lump sums over £30,000.
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 – see P50 download page on Gov uk website.
Don’t assume you have paid the right amount of tax on your redundancy payment. On large payments you could owe more.