Tax Guide for Employees guide
If you are made redundant you may assume that the tax paid on your redundancy package is correct. The problem is that the tax may not be correct once other income of the tax year is taken into account. Tax may be under paid or overpaid.
What you need to know
The first £30,000 of any redundancy payment for compensation for loss of office is free of income tax and National Insurance. Not all payments made at the time of redundancy fall into this category.
Some payments, like arrears of holiday pay, or other amounts arising out of the contract of employment, are taxable.
Any excess over £30,000 will be taxed, but the amount of tax deducted at source is unlikely to be exactly right.
The Government is currently considering changes to the law in this area. The consultation process started in autumn 2015 – see https://www.gov.uk/government/consultations/simplification-of-the-tax-and-national-insurance-treatment-of-termination-payments. By 2018, the rules will changes. This will make the position simpler, but is likely to mean that amounts over the £30,000 limit will attract employer’s National Insurance.
What might go wrong?
There is a danger of underpayment of tax where large redundancy payments have been made and the taxpayer is liable at higher rates of tax in that year. Under self assessment, the delay between the redundancy payment and the final tax bill could be up to 22 months.
Checking the tax codes – expect an 0T code
Often you will be paid a lump sum after you 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.
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.
A basic rate taxpayer is likely to slightly overpay tax on an 0T M1 code. A higher rate taxpayer is likely to underpay tax slightly on an 0T M1 code.
What if an 0T code has not been used?
If your lump sum has not been taxed using an OT code, you will need to take advice to check the impact on your final tax position for the year.
In previous years the code BR may have been used for lump sum redundancy. This is more likely to result in underpayments.
What action should I take?
This is a specialist area and a tax adviser should be consulted if there is any dispute about what elements of a redundancy package are taxable.
If the redundancy was recent, you should check your tax position with HMRC or a tax adviser to see if any additional tax, or a refund, may be due.
If you were unaware that there was an underpayment of tax on the redundancy payment, you may need advice on dealing with tax debt.
There is information on the TaxAid website in the Employee tax section