Where an individual is made redundant a tax-free amount of up to £30,000 can be paid, but care must be taken as not all termination payments qualify. In order to qualify as a tax-free payment, the sum must relate specifically to the cessation of the employment, rather than to duties already performed or to be performed in the future.
There are special rules for payments which are made to an employee after the cessation date of their contract. The leaver's form P45 will show the gross pay and tax deducted up to the date of leaving and the final PAYE code that was operated. Any payments made after the P45 has been prepared must be subjected to a BR PAYE code, which means basic rate tax is deducted from the gross amount.
The above treatment of payments issued after the P45 means that higher rate tax payers receive an initial cashflow advantage. It is important to note, however, that this is simply defering the higher rate tax due. The income will need to be declared on a self assessment return and the tax will need to be paid by 31 January following the tax year in which the sum is received. If you receive a lump sum payment this summer, that will be assessable on the tax return for the year ending 5 April 2011 and therefore any additional tax due must be paid to reach the Collector by 31 January 2012.
Where termination payments consist of a number of different sums relating to loss of office, payment in lieu of notice, holiday pay and possibly disability elements and free shares, the tax situation can be very complex. For guidance and advice, please contact your local TaxAssist Accountant.