Is Redundancy Pay Taxable? Employer Guide

One of the key benefits of redundancy pay in the UK is that it can be partially or wholly tax-free, depending on the amount and what it is made up of.

While redundancy pay can provide significant financial relief to employees, the tax treatment of these payments can vary, and employers have to be aware of the specific tax rules, thresholds, and conditions under which redundancy pay is either tax-free or taxable to manage these payments correctly.

So, in addition to ensuring employees are paid the correct amount of redundancy entitlement, employers also have to consider the tax rules on redundancy payments.

In this guide, we set out the rules for employers on when redundancy pay is tax-free or taxable, and when it is, how it should be calculated to avoid unwanted issues with HMRC.

 

Section A: What is Redundancy Pay?

 

Redundancy pay is a form of compensation awarded to employees when they are made redundant, and their employment is terminated. This situation typically arises when an employer needs to reduce the workforce because a job role is no longer required, whether due to business closure, decreased demand, or organisational restructuring.

The amount of redundancy pay an employee is entitled to typically depends on their length of service, age, and weekly pay, with specific calculations and thresholds set out by UK employment law.

Fundamentally, redundancy pay is intended to provide a financial cushion for employees who lose their jobs due to no fault of their own. It aims to ease the financial burden during the period between employment and provide some security as they search for new employment.

 

1. Legal Obligations for Employers in the UK

 

In the UK, employers have several legal obligations regarding redundancy pay. These include:

 

a. Eligibility Criteria

Employers must determine if an employee is eligible for redundancy pay. Generally, employees must have at least two years of continuous service to qualify for statutory redundancy pay.

 

b. Calculation of Redundancy Pay

Employers are required to calculate redundancy pay based on the employee’s age, length of service, and weekly pay.

The statutory redundancy pay entitlement is 0.5 week’s pay for each full year of service where the employee was under 22 years old; 1 week’s pay for each full year of service where the employee was 22 or older but under 41; and 1.5 weeks’ pay for each full year of service where the employee was 41 or older.

The statutory redundancy payment limit in the UK for employees made redundant on or after 6 April 2024, is £700 per week. Any amount of salary or wage typically earned above this weekly limit is not included in the calculation.

Redundancy pay is also capped based on the employee’s length of service, with a maximum of 20 years considered.

 

c. Notification and Consultation

Employers must follow a fair redundancy process, including providing appropriate notice and consulting with employees or their representatives about the redundancy.

 

d. Payment and Timing

Redundancy pay must be paid promptly, typically within the employee’s final paycheck or soon after their last working day. Employers must also provide a written statement explaining how the redundancy pay was calculated.

 

e. Non-Discrimination

Employers must ensure that the redundancy process is free from discrimination and complies with equality legislation.

 

f. Record Keeping

Employers should maintain accurate records of redundancy consultations, calculations, and payments to demonstrate compliance and for future reference in case of disputes.

 

Section B: Is Redundancy Pay Taxable?

 

Employers have to ensure that any redundancy payments comply with HMRC regulations. This includes distinguishing between different types of payments within the redundancy package and correctly applying the tax-free status to eligible amounts. Proper documentation and clear communication with employees regarding the tax treatment of their redundancy payments are also essential.

 

1. UK Tax Rules on Redundancy Pay

 

In the UK, redundancy pay can be either tax-free or taxable, depending on the amount and circumstances of the payment.

The tax rules are designed to provide some financial relief to employees who lose their jobs, while ensuring that larger payments are subject to appropriate taxation.

Generally, redundancy payments up to a certain limit are tax-free, but amounts exceeding this limit are subject to income tax and National Insurance contributions (NICs).

 

2. Thresholds and Limits for Tax-Free Redundancy Pay

 

The key threshold for tax-free redundancy pay in the UK is £30,000. This means that redundancy payments up to £30,000 are tax-free and do not generally attract income tax or NICs. However, any amount of redundancy pay over £30,000 is subject to income tax, but not NICs.

Importantly, this £30,000 threshold includes not just the statutory redundancy pay but also any additional redundancy payments made by the employer, such as ex-gratia payments or severance pay.

 

3. When Does Redundancy Pay Becomes Taxable

 

Redundancy pay becomes taxable under the following conditions:

 

a. Exceeding the £30,000 Threshold: Any part of the redundancy payment that exceeds £30,000 is subject to income tax. For example, if an employee receives £50,000 as a redundancy payment, £30,000 is tax-free, while the remaining £20,000 is taxable.

b. Payments in Lieu of Notice (PILON): If the redundancy payment includes a payment in lieu of notice, this amount is generally taxable, regardless of the £30,000 threshold. Employers must include PILON in the employee’s taxable income.

c. Accrued Holiday Pay: Any payment for accrued but untaken holiday is considered taxable income and is not part of the tax-free redundancy pay.

d. Non-Cash Benefits: If the redundancy package includes non-cash benefits, such as a company car or other perks, these may also be subject to tax.

e. Contractual Payments: Any redundancy payments that are contractual rather than statutory may be subject to different tax rules. Employers should ensure that any contractual redundancy payments are reviewed for tax implications.

 

Employers must carefully calculate and report redundancy payments to ensure compliance with tax regulations. This includes distinguishing between different types of payments within the redundancy package and correctly applying the tax rules to each component. Accurate record-keeping and timely communication with HMRC are also essential to avoid any penalties or disputes.

 

4. Tax-Free Redundancy Payments

 

To illustrate the tax rules on redundancy payments, the following are examples of situations when redundancy pay would be tax-free:

 

a. Statutory Redundancy Pay Only

An employee with ten years of service is made redundant and is entitled to £15,000 as statutory redundancy pay. Since this amount is below the £30,000 threshold, the entire £15,000 is tax-free.

 

b. Total Redundancy Payment Below £30,000

An employee receives £10,000 as statutory redundancy pay and an additional £15,000 as an ex-gratia payment from the employer. The total redundancy payment is £25,000, which is below the £30,000 tax-free limit. Therefore, the entire £25,000 is tax-free.

 

c. Mixed Payments with a Tax-Free Component

An employee is entitled to £20,000 as statutory redundancy pay and receives an additional £20,000 as an ex-gratia payment, making a total of £40,000. The first £30,000 of this total payment is tax-free. The remaining £10,000 is taxable as income, but no NICs are due on this portion.

 

d. Inclusion of Payments in Lieu of Notice (PILON)

If an employee’s redundancy package includes a £5,000 payment in lieu of notice (PILON) and £25,000 as redundancy pay, the PILON is taxable. The £25,000 redundancy pay is tax-free as it is within the £30,000 limit. Thus, the employee pays tax on the £5,000 PILON but not on the £25,000 redundancy pay.

 

e. Redundancy Pay Combined with Other Non-Taxable Payments

An employee receives £18,000 as statutory redundancy pay and £12,000 as a discretionary severance payment, totalling £30,000. Additionally, they receive £5,000 as a reimbursement for relocation expenses, which is also tax-free under certain conditions. In this scenario, the £30,000 redundancy payment is entirely tax-free, and the £5,000 relocation reimbursement is also not subject to tax.

 

Section C: Taxable Redundancy Payments

 

Beyond the tax-free threshold, certain conditions and specific payment components can trigger tax liabilities. Employers must accurately calculate and report taxable redundancy payments to ensure compliance with HMRC regulations and to provide clear information to employees.

 

1. How to Calculate Tax on Redundancy Payments Exceeding the Tax-Free Limit

 

To calculate the tax on redundancy payments exceeding the £30,000 tax-free limit, employers should first determine the total redundancy payment by calculating the total redundancy payment, including statutory and any additional discretionary payments.

Next, apply the tax-free threshold to this figure. Subtract the £30,000 tax-free amount from the total redundancy payment to find the taxable portion.

Finally, apply the applicable income tax rate to the taxable portion of the redundancy payment.

 

2. Examples of Calculations

 

a. Example 1: Total Payment Exceeds £30,000

An employee receives a total redundancy payment of £50,000. The tax-free amount is £30,000, leaving a taxable amount of £50,000 – £30,000 = £20,000. If the employee’s income tax rate is 20%, the tax due on the redundancy payment is 20% of £20,000 = £4,000.

 

b. Example 2: Inclusion of PILON

An employee receives £25,000 as redundancy pay and £10,000 as a payment in lieu of notice (PILON). The total redundancy payment is £25,000, which is tax-free under the £30,000 threshold. PILON at £10,000 is fully taxable. If the employee’s income tax rate is 20%, the tax due on PILON is 20% of £10,000 = £2,000.

 

c. Example 3: Mixed Payments with Accrued Holiday Pay

An employee receives £35,000 as redundancy pay, £5,000 as PILON, and £3,000 for accrued holiday pay, making the total redundancy payment £35,000. The taxable redundancy payment is £35,000 – £30,000 (tax-free threshold) = £5,000. PILON at £5,000 is also taxable, as is the £3,000 taxable holiday pay. This makes the total taxable amount: £5,000 (redundancy) + £5,000 (PILON) + £3,000 (holiday pay) = £13,000. If the employee’s income tax rate is 20%: 20% of £13,000 = £2,600 tax due.

 

Section D: Employer Responsibilities

 

Processing redundancy pay involves a series of responsibilities for employers to ensure compliance with UK employment laws and HMRC regulations.

 

1. Steps Employers Must Take When Processing Redundancy Pay

 

a. Identify Eligibility: Determine which employees are eligible for redundancy pay. Employees must typically have at least two years of continuous service to qualify for statutory redundancy pay.

 

b. Calculate Redundancy Pay: Accurately calculate the redundancy pay based on the employee’s length of service, age, and weekly pay. Ensure the calculation adheres to statutory redundancy pay guidelines or any contractual agreements.

 

c. Provide Notice: Give appropriate notice to employees about their redundancy. The notice period depends on the length of service and must comply with statutory minimum notice periods or contractual terms.

 

d. Consultation: Engage in a consultation process with employees or their representatives. This is mandatory if 20 or more employees are being made redundant within a 90-day period.

 

e. Issue Redundancy Letters: Provide formal redundancy letters outlining the terms of redundancy, including the amount of redundancy pay, notice period, and any other relevant details.

 

f. Process Final Payments: Ensure that the final payments, including redundancy pay, any outstanding wages, accrued holiday pay, and payments in lieu of notice (if applicable), are processed correctly and on time.

 

g. Inform HMRC: Notify HMRC of the redundancy payments and ensure that any taxable portions are reported and the appropriate taxes are withheld and remitted.

 

2. Ensuring Compliance with HMRC Regulations

 

a. Adherence to Tax-Free Thresholds: Ensure that redundancy payments up to £30,000 are treated as tax-free. Any amount exceeding this threshold must be taxed accordingly.

 

b. Accurate Tax Calculation: Calculate and deduct the correct amount of income tax on taxable redundancy payments. Consider all taxable components, such as PILON and accrued holiday pay.

 

c. Timely Reporting and Payment: Report the redundancy payments to HMRC through the Real-Time Information (RTI) system. Make timely payments of any taxes due to HMRC to avoid penalties.

 

d. Maintain Up-to-Date Knowledge: Stay informed about changes in tax laws and employment regulations to ensure ongoing compliance. Regularly review HMRC guidelines and updates.

 

3. Documentation and Record-Keeping Requirements

 

a. Redundancy Calculations: Maintain detailed records of how redundancy pay was calculated for each employee, including length of service, weekly pay, and any additional payments.

 

b. Consultation Records: Keep records of consultation meetings with employees or their representatives, including dates, attendees, and key discussion points.

 

c. Redundancy Notices and Letters: Retain copies of all redundancy notices and formal letters issued to employees detailing the terms and conditions of their redundancy.

 

d. Payment Records: Document all payments made to employees as part of the redundancy process, including redundancy pay, PILON, and accrued holiday pay.

 

e. HMRC Correspondence: Keep copies of all correspondence with HMRC related to redundancy payments, including RTI submissions and any queries or responses from HMRC.

 

f. Employee Acknowledgments: Obtain written acknowledgement from employees confirming receipt and understanding of their redundancy terms and payments.

 

Section E: Common Mistakes to Avoid

 

Due to the complexity of UK tax regulations and employment laws, it’s not uncommon for employers to make errors in calculating and processing redundancy payments, which can lead to non-compliance, employee complaints and potential penalties from HMRC.

Errors employers often make in relation to redundancy pay taxation include:

 

a. Incorrect Calculation of Redundancy Pay: Miscalculating the amount of redundancy pay due to errors in considering length of service, age, or weekly pay rates.

 

b. Misapplication of the £30,000 Tax-Free Threshold: Failing to correctly apply the £30,000 tax-free limit, resulting in either over-taxation or under-taxation of redundancy payments.

 

c. Not Distinguishing Between Different Types of Payments: Confusing redundancy pay with other types of payments, such as payments in lieu of notice (PILON) or accrued holiday pay, which may have different tax treatments.

 

d. Incorrectly Taxing or Not Taxing PILON: Not properly taxing PILON, which is always subject to income tax and National Insurance contributions, regardless of the £30,000 threshold.

 

e. Failing to Report Payments to HMRC Accurately: Inaccurate or delayed reporting of redundancy payments to HMRC, leading to potential penalties and compliance issues.

 

f. Not Following Proper Consultation Procedures: Skipping or improperly conducting mandatory consultation processes which can lead to legal challenges and claims of unfair dismissal.

 

To avoid mistakes, follow these best practices:

 

a. Ensure Accurate Calculations: Use reliable payroll software or consult with HR and payroll specialists to accurately calculate redundancy pay. Verify calculations against statutory guidelines and contractual agreements.

 

b. Apply the Tax-Free Threshold Correctly: Clearly distinguish between tax-free and taxable components of redundancy pay. Ensure only the portion exceeding £30,000 is taxed.

 

c. Differentiate Between Payment Types: Clearly identify and separately handle different types of payments (e.g., PILON, accrued holiday pay, and redundancy pay). Apply the correct tax treatment to each type.

 

d. Properly Tax PILON: Always treat PILON as taxable income. Ensure it is included in the employee’s taxable earnings and that appropriate taxes and NICs are deducted.

 

e. Accurate and Timely HMRC Reporting: Report all redundancy payments accurately and promptly through the Real-Time Information (RTI) system. Keep detailed records of all transactions and submissions.

 

f. Conduct Proper Consultations: Follow legal requirements for consultation, especially in cases of collective redundancies. Document all consultation processes and communications with employees.

 

g: Stay Updated on Regulations: Regularly review HMRC guidelines and employment law updates. Attend relevant training or seminars to stay informed about changes in redundancy pay regulations.

 

h. Provide Clear Communication to Employees: Clearly explain the components of redundancy payments and their tax implications to employees. Provide written statements detailing how payments were calculated and taxed.

 

i. Maintain Thorough Documentation: Keep detailed records of all redundancy-related calculations, communications, and HMRC submissions. This helps resolve any disputes and demonstrate compliance.

 

j. Seek Professional Advice: Consult with tax professionals or legal advisers when in doubt about the tax treatment of redundancy payments. Professional guidance can help avoid costly errors and ensure compliance.

 

Section F: Summary

 

If you are unsure about your obligations, take advice from either payroll specialists or qualified tax advisers.

 

Section G: FAQs

 

What is redundancy pay?
Redundancy pay is a financial compensation given to employees who lose their jobs because their role is no longer necessary. It aims to support employees during their transition period as they seek new employment.

 

Is redundancy pay taxable in the UK?
Redundancy pay up to £30,000 is tax-free in the UK. Any amount above £30,000 is subject to income tax but not National Insurance contributions. Payments in lieu of notice (PILON) and accrued holiday pay are fully taxable.

 

What happens if redundancy pay exceeds £30,000?
If redundancy pay exceeds £30,000, the excess amount is subject to income tax. For example, if an employee receives £40,000, the first £30,000 is tax-free, and the remaining £10,000 is taxable.

 

Are payments in lieu of notice (PILON) tax-free?
No, PILON is fully taxable as it is considered part of the employee’s earnings. It is subject to both income tax and National Insurance contributions.

 

Do employers need to inform HMRC about redundancy payments?
Yes, employers must report redundancy payments to HMRC through the Real-Time Information (RTI) system. This includes both the tax-free and taxable portions of the payment.

 

What documentation should employers provide to employees receiving redundancy pay?
Employers should provide a written statement detailing the redundancy payment calculation, including statutory and any additional payments, the tax treatment of each component, and the total amount payable. This helps ensure transparency and compliance.

 

How can employers ensure compliance with HMRC regulations on redundancy pay?
Employers can ensure compliance by accurately calculating redundancy payments, correctly applying the £30,000 tax-free threshold, timely reporting to HMRC, and keeping detailed records of all redundancy-related transactions and communications.

 

What are the legal requirements for consulting with employees about redundancy?
Employers must follow proper consultation procedures, especially in cases of collective redundancies (20 or more employees within 90 days). This includes informing and consulting with employees or their representatives, providing relevant information, and considering alternatives to redundancy.

 

Can redundancy pay include non-cash benefits?
Yes, redundancy packages can include non-cash benefits, such as company cars or other perks. However, these benefits may be subject to tax, depending on their nature and value.

 

What should employers do if they are unsure about the tax treatment of redundancy payments?
Employers should seek advice from tax professionals or legal advisors to ensure the correct tax treatment of redundancy payments. Professional guidance can help avoid errors and ensure compliance with tax regulations.

 

Section H: Glossary

 

Accrued Holiday Pay: The amount of pay an employee is entitled to for any unused holiday days at the time their employment ends. This pay is taxable.

Consultation: A formal process where employers discuss proposed redundancies with employees or their representatives. This is mandatory, especially in cases of collective redundancies.

Ex-Gratia Payment: A discretionary payment made by an employer to an employee, which is not required by law or the employment contract. This payment can be part of a redundancy package and may be subject to tax if it exceeds the £30,000 threshold.

HMRC (Her Majesty’s Revenue and Customs): The UK government department responsible for the collection of taxes, the payment of some forms of state support, and the administration of other regulatory regimes, including redundancy pay taxation.

National Insurance Contributions (NICs): Payments made by employees and employers in the UK to fund various state benefits, including healthcare and pensions. Some redundancy payments are exempt from NICs.

Payment in Lieu of Notice (PILON): A payment made to an employee when they are not required to work their notice period. This payment is fully taxable and subject to NICs.

Real-Time Information (RTI): A system used by employers to report payroll information to HMRC every time they pay their employees, including details of redundancy payments.

Redundancy: A situation where an employer needs to reduce the workforce because a job role is no longer necessary due to various factors such as business closure, decreased demand, or organisational restructuring.

Redundancy Pay: Compensation provided to employees who lose their jobs due to redundancy. It includes statutory redundancy pay and any additional payments made by the employer.

Statutory Redundancy Pay: The minimum amount of redundancy pay that an eligible employee is entitled to by law, based on their length of service, age, and weekly pay.

Tax-Free Threshold: The maximum amount of redundancy pay that can be received without being subject to income tax. In the UK, this threshold is £30,000.

Taxable Redundancy Payment: The portion of redundancy pay that exceeds the tax-free threshold of £30,000 and is subject to income tax. This includes any additional discretionary payments and certain other components of the redundancy package.

 

Section I: Additional Resources

 

UK Government Guide to Redundancy Pay
https://www.gov.uk/staff-redundant/redundancy-pay

 

HMRC (HM Revenue and Customs) Redundancy Payments and Tax
https://www.gov.uk/termination-payments-and-the-tax-treatment-of-these

 

Redundancy: Your Rights
https://www.gov.uk/redundant-your-rights/redundancy-pay

 

Tax and Termination Payments (HMRC Manual)
https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim13750

 

ACAS (Advisory, Conciliation and Arbitration Service) Redundancy Advice
https://www.acas.org.uk/redundancy

 

CIPD Guide to Redundancy Procedures
https://www.cipd.co.uk/knowledge/fundamentals/emp-law/redundancy/factsheet

 

Law Society – Redundancy Advice for Employers
https://www.lawsociety.org.uk/topics/employment-law/redundancy-advice-for-employers