Advanced Taxation (UK) · Income tax: income from employment

Termination Payments and Redundancy Tax Treatment

Updated 11 October 2026 · Fact-checked

Termination payments are split into layers. Contractual pay, PILON written into the contract, accrued holiday pay and PENP are taxable earnings with Class 1 NIC. The remaining award is exempt up to £30,000 and the excess is taxable, with 15% employer Class 1A NIC but no employee NIC.

Understand Termination Payments and Redundancy

When an employment ends, the employee often receives several payments. Each one is taxed differently, so the first job is to sort them into layers.

The first layer is ordinary earnings. This covers salary up to the leaving date, bonuses already earned, accrued holiday pay and any payment the contract entitles the employee to. A PILON (payment in lieu of notice) written into the contract is in this layer. It is taxable earnings with Class 1 NIC for both employee and employer.

The second layer is PENP (post-employment notice pay). If the employee is not made to work all of the notice period, the basic pay for the unworked notice is treated as earnings. This applies even where there is no PILON clause and even where the payment is described as compensation. It is taxable as earnings and attracts Class 1 NIC. Only basic pay counts for PENP, not benefits or bonus.

The third layer is the remaining termination award. This covers redundancy pay, ex gratia compensation for loss of office and similar sums. The first £30,000 is exempt from income tax, and statutory redundancy pay uses up part of that £30,000. The excess over £30,000 is taxable as employment income. There is no employee NIC on it, but the employer pays Class 1A NIC at 15% on the excess.

As a result, a large package can be taxed very differently from the way it is labelled. Examiners test whether you can separate the layers and apply the right tax and NIC to each. Payments for a restrictive covenant are taxable as earnings, and payments on death, injury or disability are outside the normal rules. Check the facts for these.

Key rules to remember

Taxable earnings layer: Final salary + accrued holiday pay + contractual payments (including contractual PILON) + PENP; Taxable as employment income. Class 1 NIC applies to the employee and the employer.
PENP: PENP = basic pay for the unworked part of the notice period; Taxable as earnings with Class 1 NIC. Any basic pay already paid for the notice period is not counted twice. Only basic pay is included.
Remaining termination award: Taxable amount = remaining award − £30,000 (minimum nil); Statutory redundancy pay is part of the award and uses up the £30,000. The excess is taxable employment income.
Employer Class 1A on the excess: Class 1A = 15% × (termination award in excess of £30,000); The rate is in the NIC table. No employee NIC arises on this excess.
Employer Class 1 on earnings layer: 15% × earnings above £5,000 a year; Employee Class 1: 8% on £12,571 to £50,270 and 2% above. Take care with how much of the thresholds earlier pay has used.

How to solve Termination Payments and Redundancy questions

Work through the payments in a fixed order so that nothing is taxed twice or missed.

1List every payment and its date. Note whether the contract entitles the employee to it.
2Pull out the earnings layer first: final salary, bonus earned, accrued holiday pay and any contractual payment including contractual PILON.
3Check whether the employee has worked the full notice period. If not, calculate PENP from basic pay for the unworked notice and add it to the earnings layer.
4Add up the earnings layer. This is taxable and subject to Class 1 NIC (employee and employer). Use the NIC rates and thresholds given and say if earlier pay has already used the thresholds.
5Total what is left (redundancy pay, ex gratia and other compensation). Include statutory redundancy pay. Deduct the £30,000 exemption, down to a minimum of nil.
6Treat the excess as taxable employment income. Apply the Class 1A rate of 15% for the employer. State that there is no employee NIC on the excess.
7Add the taxable amounts to the other income and compute the tax at the rates the employee faces. Give your answer to the nearest £ and show every working.

Quickest way: Three-bucket sort

When to use it: Use this when a question lists several payments on leaving and asks for the taxable amount or the NIC cost.

Bucket 1 is earnings: salary, holiday pay, contractual items and PENP. Taxable and Class 1 NIC.
Bucket 2 is everything else paid for the loss of job. Add it up and take off £30,000.
Bucket 3 is the excess over £30,000. Taxable, with 15% Class 1A for the employer and no employee NIC.
Write the total taxable amount as bucket 1 plus bucket 3. Then do the NIC lines separately.

Common mistakes in Termination Payments and Redundancy

Treating all of a package as one lump and giving the £30,000 exemption against everything.
Students remember the £30,000 figure and forget that earnings and PENP are taxed first.
Fix: Take out salary, holiday pay, contractual PILON and PENP before you apply the £30,000 exemption.
Treating PILON as exempt because it is paid on termination.
The word termination suggests the £30,000 rules apply.
Fix: A PILON that the contract provides for is earnings. If it is not in the contract, the PENP rules still make the basic pay for unworked notice taxable as earnings.
Charging employee NIC on the excess over £30,000.
Students link taxable and NIC automatically.
Fix: The excess is taxable but the employee pays no NIC on it. The employer pays Class 1A at 15%.
Leaving statutory redundancy pay out of the £30,000.
Redundancy pay looks like a separate exempt amount.
Fix: Include statutory redundancy pay in the remaining award. The £30,000 covers the combined total.
Including bonus or benefits in the PENP calculation.
Students use total package value.
Fix: PENP is based on basic pay only. Other pay that the contract gives is taxed as earnings in its own right.
Forgetting the employer's NIC cost in a planning question.
The focus stays on the employee's tax.
Fix: Always show Class 1 on the earnings layer and Class 1A on the excess when the question asks for the cost to the company.

Worked examples

Example 1

Priya is made redundant. She is paid off before working her notice. Her contract has no PILON clause. Her basic pay for the unworked notice period is £12,000. She also receives statutory redundancy pay of £9,000 and an ex gratia payment of £35,000. Calculate the amount of the payments that is taxable as employment income and the employer's Class 1A NIC. Ignore her final salary.

Show the solution

The PENP of £12,000 is taxable as earnings even though the contract has no PILON. It also attracts Class 1 NIC.
The remaining award is £9,000 + £35,000 = £44,000.
Deduct the £30,000 exemption: £44,000 − £30,000 = £14,000 is taxable.
Total taxable employment income from the payments is £12,000 + £14,000 = £26,000.
Employer Class 1A NIC is 15% × £14,000 = £2,100. No employee NIC arises on the £14,000.

Answer: £26,000 is taxable (PENP £12,000 plus excess £14,000). Employer Class 1A NIC on the excess is £2,100. The PENP also attracts Class 1 NIC.

Example 2

Ravi is a higher rate taxpayer whose earnings for the year are already above £50,270 before the following payments. On leaving he receives contractual PILON of £6,000, accrued holiday pay of £2,000 and a non-contractual redundancy payment of £25,000. Calculate his income tax on the payments, his employee Class 1 NIC on them, and the employer's Class 1 NIC. Assume the employer's £5,000 threshold has already been used.

Show the solution

Earnings layer: £6,000 + £2,000 = £8,000. This is taxable and subject to Class 1 NIC.
Redundancy payment: £25,000 is below £30,000, so it is fully exempt. No tax, no Class 1A.
Income tax: Ravi pays 40% on £8,000 = £3,200.
Employee Class 1: his earnings are already above £50,270, so 2% × £8,000 = £160.
Employer Class 1: 15% × £8,000 = £1,200.

Answer: Income tax £3,200. Employee Class 1 NIC £160. Employer Class 1 NIC £1,200. The £25,000 redundancy payment is exempt and carries no NIC.

Exam tips

Set out a short table of the payments first, with a column for earnings or termination award. It earns marks and prevents slips.
State the reason for each treatment, such as contractual, PENP or within the £30,000, because Section A marks are for applying the rule.
Say clearly that the employee pays no NIC on the excess over £30,000 but the employer pays 15% Class 1A. This is a frequent point.
When a question asks for advice, mention how to restructure payments. Employer contributions into a pension may be a tax-efficient alternative to part of a lump sum. Link this to planning and professional skills marks.
Use the NIC and income tax tables provided. Do not rely on memory for rates.

Practice questions from Income tax: income from employment

Termination Payments and Redundancy: frequently asked questions

How are redundancy payments taxed in the UK?

Statutory and other redundancy payments form part of the termination award. The first £30,000 of the award is exempt from income tax. The excess is taxable as employment income and the employer pays 15% Class 1A NIC on it.

What is PENP and how is it taxed?

PENP is post-employment notice pay. It is the basic pay for any part of the notice period that the employee does not work. It is taxed as earnings and attracts Class 1 NIC, whether or not the contract has a PILON clause.

Is PILON always taxable?

A PILON that the contract provides for is taxable earnings with Class 1 NIC. Where there is no such clause, the PENP rules still treat the basic pay for unworked notice as earnings. Only the remainder of the award can use the £30,000 exemption.

Does the £30,000 exemption apply to each payment separately?

No. It is one exemption against the total of the remaining termination award. Earnings and PENP are taken out first, and statutory redundancy pay uses part of the £30,000.