The following Personal Tax guidance note by Tolley provides comprehensive and up to date tax information covering:
Termination payments are payments compensating an individual for the loss of his job. The law on termination payments also covers payments for varying the terms of an individual’s employment relating to their pay and duties (which can include loss of rights).
Termination payments can take the form of cash or benefits in kind. The payment will either be fully taxable, partially taxable, or fully exempt depending on the nature and the amount of the payment.
Depending on the circumstances, termination payments can be treated for tax purposes as:
It is the employer’s responsibility to tax the termination payment correctly and therefore the employer bears the risk of tax and penalties if the treatment is wrong. This is an area where HMRC sees frequent mistakes in the tax treatment and it has targeted such payments in the past.
The tax analysis of an individual’s termination payment should have been done by the employer. However, it is important to be aware of these points.
See the GOV.UK website for a refresher of the essential employment law on dismissal. See also the Termination of employment guidance note and other guidance notes in the Dismissal sub-topic of the Employment Taxes module for more information (subscription sensitive).
Before deciding how to treat the termination payment for tax purposes, the total payment must be broken down into its component elements. Once identified, the tax treatment of each element is decided by matching it to the categories above.
So, how do we identify the component elements of the termination payment? It relies broadly
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