If you are wondering if settlement agreements are taxable in the UK or want to find out more about them in general, then you have come to the right place. This guide will help you find out everything you need to know about taxable settlement agreements as well as educating you on employment law, so you can make the right decisions when it comes to your finances.

What is a Settlement Agreement?

A settlement agreement is a written agreement between two or more parties that ends a legal dispute or possible lawsuit. It is a way for the parties to reach an amicable conclusion without going to court.

A number of legal conflicts, including ones involving employment, personal injuries, and business, can be resolved by settlement agreements. A settlement agreement may be used to settle a conflict between an employer and employee in the context of employment, such as a claim of wrongful termination.

The settlement agreement often specifies the parameters of the settlement, such as the sum of any monetary compensation or other benefits, the extent of any claim releases, and any additional agreements that the parties agree to.

Are Settlement Agreements Taxable?

Settlement agreements, previously known as compromise agreements, are taxable in the UK. Usually, an employer will send you this kind of agreement because your employment is coming to an end. When you leave a job, whatever payments you receive will be termination payments. It doesn’t matter whether it is a compensation payment for unfair dismissal, a redundancy payment or even pay in lieu of notice because it’s all seen as a termination payment in the eyes of HMRC.

Some payments made under a settlement agreement are always taxable; these include salary to the date of termination, holiday pay, payments in lieu of notice and any other payments that are contractual.

However, it’s important to know that the first £30,000 of a compensatory settlement payment is tax-free. This also applies to redundancy payments. This is often called a compensation payment. Sometimes it’s referred to as being an ex-gratia payment, which translates to “a gift”. In other words, your employer was not obligated to pay this as a condition of your employment. A settlement agreement can also be used in the context of redundancy. This is a way for an employer to avoid the procedure of redundancy. Payments made for employment-related claims, such as discrimination or unfair dismissal, are also exempt from tax up to £30,000.

About Statutory Redundancy Payments

Your settlement agreement will generally be taxable, but there are some instances where you may qualify for a specific tax exemption. As an employer or an employee, you need to make sure that you consider the implications of any agreement as the tax implications can have a huge impact on your take-home pay. A statutory redundancy payment is a legal entitlement for employees with at least 2 years’ continuous service who  are made redundant. It’s calculated by reference to your length of service and also takes into account your weekly pay and your age. It is subject to a cap, which will change as the years go by. You can calculate what you may be entitled to by using this redundancy calculator pay site. Your contract could entitle you to far more than the minimum should you be made redundant. This is known as a contractual or enhanced redundancy payment. Redundancy payments are not taxable up to £30,000. You don’t get a separate £30,000 threshold for every sum you get.

Payments to Pension Funds

Termination payments that go into your pension fund can generally be made tax-free and you may also qualify for tax relief on the amount you pay in, boosting its value. There is a lot of separate guidance regarding this so make sure that you look into that when discussing what to do with your money. If you have experienced an injury at work, or if you are disabled as the result of your work and you receive payment for it then this would also be tax-free. There is a category of tax known as disability exemption. If the injury happened before your employment came to an end, then it’s not subject to tax, but if it happened as a result of the termination then this would be taxed.   Similarly, payments made for injury to feelings in discrimination cases or for psychiatric injury that occurs before the termination of employment can be paid free of tax and national insurance contributions.  If the compensation is paid for the employee having suffered unlawful discrimination over a prolonged period of time during the employment but not in relation to the termination itself, it will not be liable to tax.  Payments made to a solicitor advising you on your settlement agreement, before it becomes binding, do not involve a tax payment either. The main reason for this is because the money will be sent by your employer directly to the solicitor, and the settlement agreement will state this.

Importance of Hiring an Expert

If you aren’t sure if you are getting the right payment for your redundancy or if you want to find out more about the tax implications of a settlement agreement then the best thing that you can do is hire an employment law specialist. When you do this, you can then get the help you need to know that your agreement is structured properly and that you are getting the maximum tax benefits. Hiring an employment law specialist will also ensure that you are made aware of and can take advantage of upcoming, or changing laws, so keep this in mind. If you’re looking for advice on settlement agreements UK from an employment law specialist please don’t hesitate to get in touch. We would be more than happy to help you with any settlement payments you are due to receive, while also aiding you in regard to getting the most out of your payment. We can’t wait to be of assistance and we are here to answer any questions you may have