Redundancy Pay Tax

An employee with at least 2 years of service is entitled to redundancy pay if they are made redundant. Understanding redundancy pay tax is essential if you are at risk of redundancy. You will also want to understand if there has been an Unfair Dismissal and if the procedure of redundancy was fair.

What is redundancy and redundancy payments?

The statutory definition of redundancy is found under section 139 of the Employment Rights Act 1996, but it generally occurs when a role is no longer needed. Redundancies often occur when a workforce size is reduced due to a business closure, company restructuring, or technological advancements.

Redundancy payments are the compensation provided to employees who are made redundant. When a person is made redundant, the typical payments to be made are:

1. Statutory Redundancy Payment (calculated using a formula).
2. Notice Pay.
3. Holiday Pay (if you have any accrued but unused holiday pay when your employment ends).
4. Enhanced Redundancy Pay (if applicable, there may be a contractual entitlement to an enhanced payment).

Understanding the tax implications of redundancy payments is crucial to avoid an unexpected tax bill.

Statutory Redundancy Pay

A statutory redundancy payment is calculated according to the employee’s length of service, age and gross weekly pay (up to the specified limit). The calculation is identical to the one used for the basic award (an element of compensation used for unfair dismissal claims).

The employee will receive 1.5 weeks’ gross pay for each year of employment in which they were not below the age of 41, 1 week’s gross pay for each year of employment in which they were at some point below the age of 41 but not below the age of 22 and 0.5 week’s gross pay for each year of employment in which they were at any point below the age of 22. The maximum number of years you can be paid is 20.

Only full years completed can count toward the calculation. The week’s pay limit is also increased each year. You will use your actual weekly pay for the calculation unless it is more than the upper amount (in which case you use the upper amount).

Redundancy Pay Tax

Statutory Redundancy Pay

The statutory redundancy payment, taken on its own, can be paid tax-free.

Statutory redundancy pay falls within the £30,000 tax exemption on compensation for termination of employment under section 403 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) (under current limits, a statutory redundancy payment could never exceed £30,000).

Notice Pay

The amount of notice you are entitled to is most likely in your employment contract. There is also a statutory minimum notice period.

The statutory minimum notice period is:

• If you have worked for your employer for between one month and two years, one week’s notice
• If you have worked for them for between two and twelve years, one week’s notice for each year you have been employed
• If you have worked for them for more than twelve years, twelve weeks’ notice

Notice Pay is taxable.

Understanding payment in lieu of notice is crucial to determining whether you will have to work your notice.

Holiday Pay

When your employment ends, if you have accrued a holiday you are not taking, you will be entitled to be paid for this amount. For example, if you have accrued 5 days, you will receive 5 days extra pay to reflect this.

Holiday pay is taxable.

Enhanced Redundancy Pay

Some employees are entitled to “enhanced” redundancy payments that exceed the statutory entitlement. For example, there may be a contractual entitlement, or the employer may have a policy entitling its employees to be paid an enhanced rate.