Tax Implications of Redundancy for Employers and Employees
In these challenging times companies are being forced to consider restructuring in a bid to have leaner cost structures and in some cases, to survive.
Consequently the prospect of redundancy has, unfortunately, become a reality for many SMEs and their employees. This Information Bulletin seeks to outline the tax implications from both an employee and employer perspective.
Employee Perspective:
Redundancy payments exempt from tax:
The main redundancy payments which are exempt from tax are statutory redundancy payments (e.g. what an employee is entitled to under employment legislation, where they meet the eligibility criteria) and any payment made on account of injury or disability. Ex gratia payments/ lump sums, made by an employer may qualify for potential tax relief depending on circumstances.
Redundancy payments not qualifying for relief from tax:
Where a lump sum payment is received on termination of contract and such a payment was provided for in the contract of employment, this payment is charageable to income tax, in full, in the normal way.
Tax Payable:
Tax on a lump sum is payable in the year the employee leaves the employment. The rate of tax chargeable depends on the income in the given year.
PRSI, Health Levy and Income tax Levy:
Certain lump sum payments made to employees when they leave their employment are not reckonable earnings for PRSI purposes. Examples of such payments are redundancy payments, gratuities or ex-gratia lump sum payments and payments in lieu of notice to an employee when they retire or leave their employment.
However, a Health Levy (Class K contribution), and also the income tax levy is payable on the taxable portion of the lump sum payment.
Pay in lieu of notice
Any payment in lieu of notice over and above the statutory entitlement whether in cash or in some other form will be taxable but may qualify for some relief.
Determining the taxable portion of a lump sum payment:
The amount of relief reduces the taxable portion of the lump sum received. For example if the lump sum received was €20k and the relief was €2k, the taxable portion of the lump sum after relief would be €18k.
There are 3 types of relief available. On receipt of a first redundancy payment the employee can avail of the highest of these three reliefs outlined below.
1. Basic Exemption
Employees are entitled to receive a tax free, ex gratia payment of €10,160 plus €765 for each full year of service with their employer. This is in addition to the statutory entitlement.
Example:
Joe has worked for his employer for 10 years. His employer has agreed to pay him an ex gratia payment of €50,000. He will be entitled to relief of €17,810(€10,160 + €765 x10).The remainder, €32,190 is taxed.
Part-time employees will effectively be treated as full time when calculating the period of service. Career breaks are excluded from the period of service.
2. Increased Exemption
In certain circumstances an employee will be entitled to an increased exemption over and above the Basic Exemption outlined above.
An increased exemption of €10,000 is available to employees who either are not a member of an occupational pension scheme or have given up the right (irrevocably) to receive a lump sum from the pension scheme, where no relief has been claimed in respect of a lump sum received in the previous ten years.
Where an employee is a member of an occupational pension scheme the tax increased exemption is reduced by either:
• The tax free lump sum to which an employee is immediately entitled; or
• The present day value of the pension lump sum at the date of leaving employment which may be receivable in the future
If such a payment is greater than €10,000 then no extra relief is available.
Example:
Taking the previous example, if Joe was entitled to a pension lump sum of €5,000, his increased exemption is €17,810 + (10,000 – 5,000) = €22,810.
3. Standard Capital Superannuation (SCSB)
This provides relief to the value of:
A B Value of any tax
_ x _ LESS free pension = Relief
3 15 lump sum
Where:
A = Total Emoluments* for the past 3 years
(*Income, BIK plus any other benefits)
B = Years of service
If Joe earned a total salary of €70,000 per annum and BIK of €5,000 per annum over the last three years his position is as follows
(70,000 + 5,000) x 3 10
____________ x _ = €50,000
3 15
Relief before deduction of pension €50,000
Less pension lump sum (€5,000)
_______
Amount of relief €45,000