As it currently stands not all payments under a settlement agreement are tax-free but it is common place for the first £30,000 of any settlement payment (compensation for loss of office) to be paid free from any tax and NI deductions.
If you have a contractual right to be paid in lieu of notice (PILON) the entire sum will be subject to tax and NI deductions. If your contract is silent on PILON it is currently regarded as ‘damages for breach of contract’ and the first £30,000 can be paid free from tax and NI deductions.
From April 2018 all PILONs will be taxable and subject to NIC deductions.
Also, from April 2018:
The current regime is that the first £30,000 of any non-contractual termination payment is tax free and any sum over £30,000 is only subject to tax deductions and employer/ee NICs is not due.
The £30,000 limit has been in place since 1988 and the government has no place to increase this figure in line with inflation.
From April 2018 employer NICs will be due on any balance over £30,000 which will increase the cost of termination payments for employers. There will be no change in respect of employee NICs.
For clarification purposes the government has stated that payments for injury to feelings will only be exempt if they relate to a psychiatric injury or other recognised medical condition.
Any injury to feeling payment where discrimination is not related to the termination can be paid tax-free.
The payment of solicitors’ fees will remain exempt from income tax and NIC’s.
Termination payments to UK resident employees can currently be exempt if they relate to periods spent working outside of the UK. This exemption will be removed from April 2018 but employees with foreign service may benefit from a limited exception.