Termination payments paid to employees as compensation for loss of employment are a popular area in the 20-mark Advanced Tax questions.
The most important point to remember is that the £30,000 exemption is only available if the payment is non-contractual (ex-gratia) and does not coincide with retirement.
Statutory redundancy is always tax free but reduces the £30,000 exemption.
With regard to payments in lieu of notice (PILON) these are taxable as part of the contractual entitlement.
Finally, the taxable termination payment is treated as the top slice of income and taxed after the dividend income.
Jack was made redundant and received statutory redundancy of £6,000. His termination payment consisted of a payment in lieu of notice of £7,000 and an ex-gratia payment of £40,000.
If Jack is a higher rate taxpayer, how much income tax is payable?
The £6,000 statutory redundancy is tax free but will reduce the £30,000 exemption to just £24,000.
The PILON is taxable in full.
With the non-contractual payment, the first £24,000 will be tax free and the balance of £16,000 is taxable.
The total taxable amount is £7,000 + £16,000= £23,000 which will be taxed at 40% giving £9,200 in income tax.
Tax is technical and I recommend you get a copy of Advanced Tax Condensed to help you. This uses accelerated learning techniques to quickly master the key information.