Tax Implications of Being Made Redundant From Your Job

Losing your job can be an incredibly stressful experience – but sometimes the blow is softened by a payment from your former employer. Unfortunately the tax consequences of receiving such a payment can be quite complicated, which means you need to understand exactly why you have received the payment and your potential tax obligations relating to this payment.

It's also important to understand whether your redundancy is genuine or non genuine, in tax terms, as this can impact the way you are taxed on any payments.  

A genuine redundancy payment is made to you as an employee if you're dismissed because the job you were doing has been abolished. This means your employer has made a decision that your job no longer exists, and your employment is to be terminated.  

A non-genuine redundancy occurs when the employee is dismissed because they've reached normal retirement age, is their pension age or older on the day of dismissal, leaves voluntarily, has their contract terminated or is dismissed for disciplinary or inefficiency reasons.

Payments when leaving a job are often large and the tax implications are often unclear, so if you have received such a payment, it is strongly advised that you seek professional tax advice on how it should be treated.

TYPES OF PAYOUTS

Most payments upon leaving employment take one of three forms: a redundancy payment, an early retirement payment or an employment termination payment (ETP). Sometimes, just to complicate matters, payments can be a mixture of two types. Whilst redundancy and early retirement payments are taxed in similar ways, ETPs are taxed very differently so it's essential to understand the details of the payment you are receiving.

REDUNDANCY PAYMENT

A genuine redundancy payment is given to an employee when they are dismissed from their job as the job itself has been abolished.

Such payments are tax-free up to certain limits and might include:

• Payment in lieu of notice

• Severance payment of a certain number of weeks pay for each year of service

• A gratuity or 'golden handshake'

Although there is a tendency for many employees who lose their job to try to claim any final payment as related to redundancy, a true redundancy payment must meet a substantial list of criteria to qualify. If it doesn't qualify, it's taxed as an employment termination payment.

The following payments are never part of a genuine redundancy payment, but nor are they treated as ETPs:

• Salary, wages or allowances owing to you for work done or leave already taken for work completed

• Lump sum payments of unused annual leave or leave loading paid on termination of employment

• Lump sum payments of unused long service leave paid on termination of employment under a formal arrangement

• Superannuation benefits (these may be subject to concessional tax treatment)

Genuine redundancy payments are taxed at special rates, and part of the redundancy payment can be paid tax-free. The tax-free limit consists of two elements: a base amount and an annual amount for each full year of service, and both are indexed annually. For 2023-24 year, the base amount is $11,985 and the annual service amount is $5,994. For the 2024-25 year the base amount is $12,524 and the annual service amount is $6,264.

Any amount over the tax-free limit is treated as an employment termination payment.

EARLY RETIREMENT

Approved early retirement is a scheme that an employer can put into place to encourage certain groups or classes of employees to retire early or resign. For this scheme to be eligible for tax concessions, it must be open to all employees or all employees of a certain class (for example, those in a defined age range or with a certain skill set) and must be approved by the Commissioner of Taxation before any payments are made.

Early retirement scheme payments are tax free up to a limit based on the number of years the employee has worked for their employer. To qualify for these payments:

• Retirement must be "early" i.e. earlier than 67, or before any other compulsory retirement age, if sooner

• Payments must be at "arms-length" values

• There must be no arrangement for re-employment

The tax-free limit is the same as for a genuine redundancy payment, and any amount over the tax-free limit is treated as an employment termination payment.

EMPLOYMENT TERMINATION PAYMENTS (ETPS)

The third category of payment is probably the most common in practice: Employer termination payments or ETPs. These are lump sum payments made to an employee when they cease working for their employer. Common examples of ETPs include golden handshakes, contractual termination payments, payments for unused sick leave, payments for unused roster days off, payments in compensation for loss of employment or wrongful dismissal, and payments in lieu of notice of termination.

As already established, genuine redundancy payments and early retirement schemes are not ETPs up to the tax-free limit, but any excess over that limit is taxed as an ETP.

ETPs are taxed differently depending on whether they relate to the termination of the taxpayer's employment ( "life benefits") or to a termination of employment arising as a result of the death of the employee ( "death benefits").

In some cases, part or all of an ETP may be tax-free. The two instances where this might be the case are where part of the payment relates to:

• Invalidity

• Employment prior to 1 July 1983 (although such payments are now rare)  

ETPs are taxed at concessional rates (either 17% or 32%) up to a certain limit, or 'cap', and the top rate of tax applies to any amounts in excess of the cap.

The actual tax calculation for an ETP can be very complex, due to the two caps that each comes with different rules, and the way your ETP is taxed depends on which cap applies to you.

If you've received an ETP during the year, it is strongly advised that you use a tax professional, such as one of the expert tax agents at H&R Block, to help you work out your tax liability.