The first £30,000 of a genuine termination payment is usually free of Income Tax and employee National Insurance. Everything you have earned — salary, holiday pay, bonuses and notice pay — is taxed in full and does not count towards the £30,000.
What the exemption covers
It is a single combined threshold across all qualifying termination payments connected with the same employment, not £30,000 per payment.
It applies to genuine compensation for loss of employment, not to contractual entitlements. Statutory redundancy pay and qualifying enhanced redundancy pay count towards the same threshold.
Amounts above £30,000 are subject to Income Tax at your marginal rate through PAYE, and your employer pays Class 1A National Insurance on the excess. Employee National Insurance is not charged on the termination award.
Calling a taxable payment “compensation” does not change its treatment. HMRC looks at substance.
The PENP trap
This is where offers most often go wrong, and the main reason to have an agreement properly reviewed rather than rubber-stamped.
Since 6 April 2018 all payments in lieu of notice are treated as earnings and taxed in full, and the post-employment notice pay rules ensure any part of a termination payment representing unworked notice is taxable. PILON and PENP amounts do not benefit from the £30,000 exemption.
The statutory formula in section 402D ITEPA 2003 is:
PENP = ((BP × D) ÷ P) − T
- BP — basic pay in the last pay period ending before the trigger date
- D — calendar days in the post-employment notice period
- P — calendar days in the last pay period
- T — any payment received in connection with the termination already chargeable to income tax outside the termination payment rules
PENP is subject to income tax and both employee and employer NICs in full. The balance of the relevant termination award, with any statutory redundancy payment, is eligible for the £30,000 exemption. If PENP exceeds the severance you actually receive, you only pay tax on what you get.
A worked example. An employer offers £35,000 and describes £30,000 of it as tax free. You have three months’ unworked notice on a £60,000 salary. Roughly £15,000 of that £35,000 is PENP and taxable in full. The genuinely exempt element is £20,000, and your net receipt is thousands below what you expected. Always ask for the calculation before you sign.
Treatment at a glance
| Payment | Taxed as earnings? | Counts to £30,000? | Employee NICs? |
| Salary to termination | Yes | No | Yes |
| Accrued holiday pay | Yes | No | Yes |
| Earned bonus or commission | Yes | No | Yes |
| Contractual PILON | Yes | No | Yes |
| PENP | Yes | No | Yes |
| Payment for new restrictive covenants | Yes | No | Yes |
| Statutory redundancy pay | No | Yes | No |
| Enhanced redundancy pay | No, to £30,000 | Yes | No |
| Genuine ex gratia compensation | No, to £30,000 | Yes | No |
| Excess over £30,000 | Yes | — | No (employer Class 1A applies) |
| Employer contribution to your legal fees | No, if properly structured | No | No |
| Payment direct to a registered pension scheme | Generally no | Generally no | No |
Figures last reviewed [date]. General guidance only, not personal tax advice.
Legal fees and pension
Legal fees. Where the employer pays your solicitor directly under the agreement for advice on the termination, this is normally not taxable on you and does not consume the £30,000.
Pension. Employers can sometimes pay part of the severance directly into your registered pension scheme. Depending on your annual allowance position this can be materially more efficient than taking cash. Worth asking about, and worth specialist advice if the sums are large.
Injury to feelings
Treatment depends on whether the discrimination relates to the termination itself or to events during employment. The distinction is technical and litigated. Where a meaningful part of your settlement is attributed to injury to feelings, the apportionment must be reasoned and defensible — HMRC challenges artificial allocations.
The tax indemnity
Almost every agreement makes you liable to reimburse the employer if HMRC later demands more tax. The principle is usually unavoidable. The scope is negotiable.
Look for, and where possible negotiate:
- exclusion of employer NICs — you should not indemnify the employer’s own liability
- exclusion of employer error — you should not pay for their payroll mistake
- exclusion of interest and penalties not caused by you
- conduct of any dispute: the right to be notified and to have input into how HMRC is answered, rather than the employer settling and billing you
- a cap, where the sums justify it
- a reasonable time limit
On a large package this can be the riskiest clause in the document.
Before you sign
Ask for a written breakdown showing every element, the PENP calculation with the figures used, the tax and NIC deductions, and the net payable. If the employer cannot produce one, that is itself a reason to pause.