exitagreementHow a settlement agreement is taxed
Almost every page in this market says the same seven words: the first £30,000 is tax free. It is true and it is not enough, because it leaves out the three things that decide what you actually receive.
Key points
- The threshold applies to compensation for losing the job. Earnings — notice, holiday, wages, bonus — are taxed in full whatever the agreement calls them.
- It is not an allowance you get. It is a threshold below which a qualifying payment is not charged.
- It is aggregated across the same employment, other employments with the same employer, and employments with associated employers (s.404).
- Post-employment notice pay is the rule that matters most in practice. It calculates the notice element arithmetically and taxes it as earnings, whatever the label.
- What is taxed is fixed by the facts, not by the drafting. Relabelling does not work.
The rule itself
The amount of a payment or benefit to which this section applies counts as employment income of the employee or former employee for the relevant tax year if and to the extent that it exceeds the £30,000 threshold.Read the section on legislation.gov.uk
Two words in that sentence carry the whole thing. Exceeds — the charge applies to the excess, not to the whole payment once you cross the line. And threshold — not allowance, not relief, not exemption. Nothing is given to you; a charge simply does not arise until you go past it.
The practical difference matters when a payment is split across tax years or across employers, which is where the next section comes in.
The same diagram as a table
| Part | What it covers | Amount | Tax treatment |
|---|---|---|---|
| Part 1 — contractual | Notice pay, holiday pay, unpaid wages, bonus or commission | £11,500 | Income tax and National Insurance in full |
| Part 2 — ex gratia | Statutory redundancy pay, compensation for loss of employment, injury to feelings | £34,000 | First £30,000 free of tax and National Insurance |
| Total | — | £45,500 | — |
Threshold figure: Income Tax (Earnings and Pensions) Act 2003, s.403(1). Illustrative amounts.
Which half the threshold attaches to
Only the compensation half. Acas is direct about what does not qualify: tax and National Insurance are usually deducted from wages or salary owed to you, bonuses, commission, holiday pay for leave you did not take, payment in lieu of notice (pilon).
| Element | Part | Income tax |
|---|---|---|
| Wages or salary owed to you | 1 | Taxed in full as earnings |
| Holiday pay for leave not taken | 1 | Taxed in full as earnings |
| Bonus or commission already earned | 1 | Taxed in full as earnings |
| Payment in lieu of notice | 1 | Taxed in full as earnings |
| Statutory redundancy pay | 2 | Counts towards the £30,000 threshold |
| Compensation for loss of employment | 2 | Counts towards the threshold |
| Compensation for giving up tribunal rights | 2 | Counts towards the threshold |
Note what the second column does to a headline figure. An offer of £35,000 that is mostly Part 1 and an offer of £35,000 that is mostly Part 2 are not the same offer, and the difference can run to several thousand pounds. The calculator splits any figure you give it.
The mistake that costs the most: post-employment notice pay
Here is the manoeuvre the legislation was written to stop. An employer agrees to describe the notice you are not working as “compensation” rather than as pay in lieu of notice, so that it slides under the threshold. Everybody is happier, nobody deducts anything, and for a few years it worked.
Sections 402A to 402E of ITEPA 2003, inserted by the Finance (No. 2) Act 2017, s.5(3), ended it. They calculate the notice element arithmetically, from your basic pay and your dates, and treat the result as earnings.
The inputs to the calculation:
BP is the employee’s basic pay from the employment in respect of the last pay period of the employee to end before the trigger date, P is the number of days in that pay period, and D is the number of days in the post-employment notice period.Read the section on legislation.gov.uk
And the consequence:
The amount of a termination award to which this section applies is treated as an amount of earnings of the employee, or former employee, from the employment.Read the section on legislation.gov.uk
In plain terms: take your basic pay for your last full pay period, work out a daily rate, multiply it by the number of days in the post-employment notice period, and subtract any amount already taxed as earnings. Whatever is left is post-employment notice pay, and it is taxed in full — regardless of what the settlement agreement calls it, and regardless of whether both parties agreed to call it something else.
If you have a three-month notice period, are leaving immediately, and the agreement puts almost the whole figure under “ex gratia compensation”, the post-employment notice pay rule will still pull roughly three months’ basic pay back into the taxable column. That is not a risk of challenge later — it is how the payroll calculation is supposed to be run at the time. An offer that has not accounted for it is worth less than it looks.
One threshold, not one per payment
For the purpose of the £30,000 threshold in section 403(4) and (5), the payments and other benefits provided in respect of an employee or former employee which are to be aggregated are those provided— (a) in respect of the same employment, (b) in respect of different employments with the same employer, and (c) in respect of employments with employers who are associated … If payments and other benefits are received in different tax years, the £30,000 is set against the amount of payments and other benefits received in earlier years before those received in later years.Read the section on legislation.gov.uk
Three consequences that catch people out:
- Group companies. If you were employed by two companies in the same group, or transferred between them, the threshold does not reset. Employers are associated where one controls the other or both are under common control.
- Two payments, one threshold. A payment on termination and a later payment under the same settlement are aggregated, not treated separately.
- Straddling tax years. Where payments are received in different tax years, the £30,000 is set against the earlier year first. You do not get to choose the allocation that suits you.
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The timing problems nobody warns you about
Emergency tax. If the payment is made after your P45 has been issued, PAYE may be applied on a basis that over-deducts. The position corrects itself eventually, through your tax code or a repayment claim, but “eventually” can be months and the money was usually needed now.
Tax-year boundary. The relevant tax year is the year of receipt. A payment arriving on 3 April and one arriving on 8 April fall in different years, with different other income sitting behind them, and can therefore be taxed at different marginal rates. If your agreement is being finalised in March, that is worth one sentence with your adviser.
Scottish rates. Income tax rates and bands on non-savings income are set by the Scottish Parliament for Scottish taxpayers. The structure on this page is UK-wide; the rate applied to the taxable part may not be.
What we are not telling you, and why
We have not put a National Insurance figure on this page. The income tax structure above is read directly from ITEPA 2003; the National Insurance treatment of amounts above the threshold sits in different legislation that we have not verified against a primary source, and a number recalled rather than read is exactly the kind of thing this site exists not to publish.
We also do not calculate your actual tax bill. It depends on your other income in the tax year, your code, and the post-employment notice pay figure derived from your own contract. The calculator shows you where the threshold falls relative to your two parts and stops there. Why we draw the line there.
Common questions
Is a settlement agreement tax free?
Part of it can be. The first £30,000 of a qualifying termination payment is not taxed as employment income — that is s.403(1) of the Income Tax (Earnings and Pensions) Act 2003. But the threshold only applies to compensation for losing the job. Anything that is really earnings — notice pay, holiday pay, unpaid wages, a bonus — is taxed in full however the agreement labels it.
Is the £30,000 an allowance I get every time?
No, and this is the most common misunderstanding. Section 404 aggregates payments made in respect of the same employment, in respect of different employments with the same employer, and in respect of employments with associated employers. It is one threshold across the lot, not one per payment and not one per employer in a group.
What is post-employment notice pay?
It is the rule that stops notice pay being relabelled as compensation. Sections 402A to 402E of ITEPA 2003, inserted by the Finance (No. 2) Act 2017, work out how much of a termination payment represents the notice you did not work, using a formula based on your basic pay and the number of days in the post-employment notice period. Whatever that formula produces is treated as earnings under s.402B and taxed in full — regardless of what the agreement calls it.
Can I ask for more of the payment to be called ex gratia?
You can ask, and it will not change the tax. The post-employment notice pay calculation is arithmetic applied to your contract and your dates, not to the labels in the document. An employer who agrees to mislabel a payment is exposing themselves, not helping you, and the liability tends to come back.
Is National Insurance treated the same way as income tax?
Not identically, and we do not state figures here that we have not verified against a primary source. The safe general position is that the contractual elements attract National Insurance in the normal way as earnings, and that the National Insurance treatment of the amount above the threshold is not a mirror of the income tax treatment. Ask your solicitor or an accountant about your specific figures.
Which tax year does the payment count in?
The year it is received. Section 403(2) defines the relevant tax year as the tax year in which the payment or benefit is received, and s.403(3) sets out when that is — broadly, when it is paid or when you become entitled to require payment. Where payments straddle two tax years, s.404(4) sets the £30,000 against the earlier year first.
Will I be taxed at emergency rates?
Sometimes, if the payment is made after your P45 has been issued. It is a cash-flow problem rather than a permanent one — the position corrects through PAYE or a repayment claim — but it can mean receiving noticeably less than the agreement said, in the month it matters most.
Does the tax position differ in Scotland?
Income tax rates and bands on non-savings income are set by the Scottish Parliament for Scottish taxpayers, so the amount of tax on the taxable part can differ. The structure on this page — what is earnings, what is a termination payment, where the threshold falls — comes from UK-wide legislation and is the same throughout the UK.
Sources cited on this page
- Income Tax (Earnings and Pensions) Act 2003, s.403 — the £30,000 threshold
- Income Tax (Earnings and Pensions) Act 2003, s.404 — how the threshold applies
- Income Tax (Earnings and Pensions) Act 2003, s.402B — awards treated as earnings
- Income Tax (Earnings and Pensions) Act 2003, s.402D — post-employment notice pay
- Acas — Discussing and negotiating an offer (what tax is deducted from)
- GOV.UK — Redundancy pay
Every figure above was read from the source it is attributed to on 19 September 2026. How we check this.
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