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Compensation for loss of employment - taxation of lump sum

Information

There are various circumstances in which people receive compensation for loss of employment. The most common is where you are made redundant and you get a settlement, which may include the statutory redundancy lump sum, and a further sum negotiated by you or your trade union with the employer. If you had a fixed-term contract and it is ended early, you may get a lump sum in compensation. A lump sum that is payable as part of your pension arrangements when you retire is not in the same category.

If you receive a lump sum in compensation for the loss of employment, part of it may be tax free. The statutory redundancy lump sum is always tax free. The lump sum that you receive in compensation for loss of employment could include:

  • The statutory redundancy lump sum, which is non-taxable
  • Payment in lieu of notice. This qualifies for some tax relief, see 'Basic Exemption' below, except in the case where a contract provides for the payment of a lump sum at the end of the contract period.
  • Other compensation negotiated with your employer or ordered by a court or the Employment Appeals Tribunal.

Budget 2014: From 1 January 2014 Top Slicing Relief will no longer be available in respect of all ex-gratia lump sum payments.

The Department of Social Protection website has an online Redundancy Calculator for use in calculating the amount of redundancy payment that is due to an employee.

Tax-free entitlements

On a redundancy or retirement payment, you are entitled to the higher of the following which is then exempt from tax:

Basic Exemption

The basic exemption due is €10,160, plus €765 for each complete year of service. (This does not include statutory redundancy which is tax free.)

Basic Exemption plus Increased Exemption

An additional €10,000 called the Increased Exemption is also available in the following certain circumstances:

  • If you haven't received a tax-free lump sum in the last 10 years and you are not getting a lump sum pension payment now or in the future

If you are in an occupational pension scheme, the Increased Exemption is reduced by any tax-free lump sum from the pension scheme you may be entitled to receive.

Standard Capital Superannuation Benefit (SCSB)

This is an additional relief due that normally benefits those with high earnings and long service. It can be used if the following formula gives an amount greater than either basic exemption or Basic Exemption plus Increased Exemption.

Formula for SCSB: Take the average annual earnings over the previous 3 years (or the whole period of service, if less than 3 years), multiply this figure by the number of years service; divide by 15 and subtract the lump sum superannuation payment received or that may be receivable.

Example: You were made redundant in 2012 after 20 years service and received a lump sum of €65,000 which is your first lump sum. You also got a lump sum of €12,000 from your pension scheme. Your pay for the last 3 years before the date of leaving work was €99,000. The amount of the lump sum which is exempt from tax is the higher of the following 2 calculations:

  1. The Basic Exemption is:
    €10,160 + €15,300 ( €765 x 20 years) = €25,460
    There is no Increased Exemption as the pension scheme lump sum of €12,000 is greater than €10,000
  2. The Standard Capital Superannuation Benefit (SCSB) is:
    €99,000 ÷ 3 x 20 ÷ 15 - €12,000 = €32,000

The taxable amount of your lump sum is therefore €33,000 (€65,000 - €32,000). As the above example shows the SCSB tax relief of €32,000 is a higher amount of tax relief than the Basic and Increased Exemptions of €25,460.

Calculation of tax

A certain amount of your redundancy payment will be tax free, as described above, and the balance will be taxed. This can be taxed as part of the current year's income or at your average rate of tax in the previous 3 years - see ‘Calculating your average rate of tax’ below. This second method is known as Top Slicing Relief which is claimed at the end of the tax year – see ‘Calculating Top Slicing Relief’ below. It is most useful to people who paid tax mainly at the low rate during those 3 years, but are now paying tax at the top rate. Under the Finance Act 2013 Top Slicing Relief is not available on lump sums of €200,000 or more that are paid on or after 1 January 2013. It was announced in Budget 2014 that Top Slicing Relief will no longer be available in respect of all ex-gratia lump sum payments from 1 January 2014.

Calculating your average rate of tax

First, find your average rate of tax for previous 3 years. Calculate your total reckonable income and your total tax paid for the previous 3 years. Then divide your total tax paid by your total reckonable income and multiply it by 100 to get your average tax rate for the previous 3 years.

Example:

Year Reckonable income Tax paid
2011 €40,000 €13,000
2010 €38,000 €12,000
2009 €36,000 €11,000
Total €114,000 €36,000

Average tax rate is €36,000 ÷ €114,000 x 100 = 31.6%

Calculating Top Slicing Relief

If you were made redundant in 2012 and the taxable amount of your lump sum was €33,000, it may be taxed at your highest tax rate of 41% depending on your income for the year. If your average rate of tax for the previous 3 tax years was, for example, 31.6% as in the example above, the Top Slicing Relief is as follows:

Tax payable on €33,000 @ 41% = €13,530

Tax payable on €33,000 @ 31.6% = €10,428

Tax payable using Top Slicing Relief will be reduced by €3,102 (€13,530 - €10,428)

Top Slicing Relief is claimed at the end of the tax year in which you receive the lump sum. So, you will pay the €13,530 when you receive your lump sum and claim the €3,102 back at the end of the tax year.

The current year method is likely to be of greatest advantage to people who are made redundant early in the tax year and who do not have a high taxable income for the rest of the year, for example, if your only income for the rest of the tax year is Jobseeker's Benefit.

The amount of your lump sum that is subject to tax is not subject to social insurance (PRSI), but the Universal Social Charge may be payable.

How to apply

Your employer is obliged to deduct tax from all your income. He/she may take account of the basic exemption, that is the €10,160 plus €765 for each year of service. The Revenue Commissioners may inform the employer about the correct amount to be treated as tax free and the rate of tax to be applied to the rest. If this does not happen or if it is incorrect and you have paid too much tax, you should contact your regional Revenue office to claim a refund - see 'Where to apply' below.

You must declare the fact that you have received such a lump sum on your annual return of income to the Revenue Commissioners.

There is more detailed information in the Revenue Commissioner's leaflet Lump Sum Payments on Redundancy/Retirement.

Where to apply

Contact your regional Revenue office.

Page updated: 16 October 2013

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