How is a termination payment taxed?
Although it may not be uppermost in your mind when taking on a new employment, you can negotiate a generous severance package with your prospective employer. If you lose your job, or your job conditions are radically altered, you can get a large tax-free lump sum – known as a termination payment, or non-statutory redundancy.
Redundancy can be a stressful time for both employer and employee. Nevertheless, it is important to be aware of the tax traps and pitfalls.
A payment made to you on the termination of your employment is fully taxable unless it is compensation for the total loss of the employment. Therefore, a terminal bonus is fully taxable. Exemption only applies if the payment is for foregoing rights as an employee – or for the total cancellation of your employment contract, i.e., for losing your job. In other words, to qualify for exemption, a termination payment must be a form of damages payment made by the employer to you for breach of your contract of employment.
You are allowed a tax-free termination payment of €10,160 increased by €765 for each complete year of service. This is known as the basic exemption. The basic exemption figure may be further increased by the lower of:
(a) €10,000 if you have not claimed relief in excess of the basic exemption in the preceding 10 years, and
(b) the difference between €10,000 and the payment amount where the lump sum pension commutation payment to which you are entitled on retiring does not exceed €10,000 (but if the pension commutation payment exceeds €10,000, the increase to the basic exemption is limited to €10,000).
You only get one basic exemption for the same job or the same employer (including any associated employer).
If you are entitled to a pension on retirement, you may be entitled to further relief if the amount of your standard capital superannuation benefit (SCSB) exceeds your basic exemption. Your SCSB is calculated as:
(a) one-fifteenth of your average yearly emoluments for your last three years of employment (or the whole period if less than three years) before your departure date, multiplied by
(b) the whole number of your complete years of service,
(c) less the relevant capital sum, i.e., the present value of your right to opt, at the time you become entitled to receive your pension, to take part of the pension as a tax-free lump sum.
If your SCSB is greater than your basic exemption, you get a further exemption for the amount by which the SCSB exceeds your basic exemption. In other words, your SCSB figure can replace your basic exemption figure.