Yes, PILON is taxable in the UK. Since 6 April 2018, every payment in lieu of notice is treated as earnings and runs through payroll with Income Tax and Class 1 National Insurance deducted, whether or not your contract contains a PILON clause. The amount that must be taxed this way is set by a statutory formula called Post-Employment Notice Pay (PENP). Only sums above that figure can sit inside the separate £30,000 tax-free exemption for genuine termination payments.1GOV.UK. New Rules for Taxation of Termination Payments
Why Contract Wording No Longer Shelters PILON
Before April 2018, the tax treatment of a PILON depended on your contract. A contractual PILON was taxed as salary. A non-contractual one could sometimes be dressed up as compensation for loss of employment and sheltered under the £30,000 exemption. Employers used that gap to lower the tax bill on exits, and HMRC closed it by introducing PENP. Now the notice-pay element of a termination package is taxed as earnings regardless of what the contract says or what the payment is labelled.1GOV.UK. New Rules for Taxation of Termination Payments
How PENP Decides the Taxable Amount
PENP is a floor. Whatever your employer calls the money, HMRC calculates how much basic salary you would have earned during your unworked notice period and insists on at least that figure being taxed as earnings. The rules sit in sections 402A to 402E of the Income Tax (Earnings and Pensions) Act 2003.2Legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 402D
The formula is: PENP = ((BP × D) / P) – T.
BP (basic pay) is your employment income in the last pay period ending before the “trigger date.” The trigger date is the day notice was given, or your last day of employment if no notice was served.3GOV.UK. PENP Formula – Defined Terms Crucially, BP is basic salary only. HMRC strips out overtime, bonuses, commission, gratuities, and allowances.4HM Revenue & Customs. PENP Formula – How to Calculate BP If a large part of your usual pay is commission, none of it inflates PENP.
D (unworked notice days) is the number of calendar days from your last day of employment to the date your employer was lawfully required to let you go. If your contractual notice is longer than the statutory minimum, D uses the contractual period; if shorter, D uses the statutory minimum. Days you actually worked out of notice don’t count.5GOV.UK. PENP Formula – How to Calculate D
P (pay period) is the number of calendar days in your last pay period before the trigger date. Monthly pay means 30 or 31 days; fortnightly pay means 14.6GOV.UK. PENP Formula – How to Calculate P
T (already taxed) subtracts any part of your termination payment that has already been taxed as earnings, typically a contractual PILON put through payroll. Holiday pay and termination bonuses are not deducted here, so they don’t lower your PENP.7GOV.UK. PENP Formula – How to Calculate T
If the formula produces a negative number, PENP is treated as zero. If your employer pays a PILON smaller than the PENP figure, the higher PENP amount is still what gets taxed as earnings.2Legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 402D
A Worked Example
Take someone earning £5,000 a month in basic salary, paid monthly, with a three-month contractual notice period. The employer ends the job immediately, no notice worked, no PILON yet taxed:
- BP: £5,000
- D: 90 days
- P: 30 days
- T: £0
PENP = ((£5,000 × 90) / 30) – £0 = £15,000.
That £15,000 has to go through payroll with Income Tax and Class 1 NICs deducted. If the employer only pays a PILON of £10,000, PENP still sets the taxable floor at £15,000. Anything the employer pays on top of that, as part of a wider termination package, is then tested against the £30,000 exemption.
Tax and NIC Rates on the PENP Amount (2026/27)
Your employer deducts PAYE at your marginal rate and reports the payment through Real Time Information. For 2026/27, the rates for England, Wales, and Northern Ireland are:8GOV.UK. Rates and Thresholds for Employers 2026 to 2027
- Personal Allowance: £12,570
- Basic rate: 20% on the next £37,700
- Higher rate: 40% from £37,701 to £125,140
- Additional rate: 45% above £125,140
Scottish taxpayers are taxed under Scotland’s own bands, which run from 19% to 48% across six rates for 2026/27.8GOV.UK. Rates and Thresholds for Employers 2026 to 2027
Class 1 NICs apply to the full PENP amount. Employees pay 8% on annual earnings between £12,570 and £50,270, and 2% above that.8GOV.UK. Rates and Thresholds for Employers 2026 to 2027 The PENP figure will show up in your P45 as part of your total taxable pay for the year, so hold on to it.
What the £30,000 Exemption Still Covers
Once PENP has been carved out and taxed as earnings, the remaining genuinely compensatory parts of your termination package can benefit from the £30,000 tax-free exemption.9GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On Payments that can sit inside that exemption include statutory redundancy pay, any enhanced redundancy pay your employer offers above the statutory amount, and non-cash benefits such as company property you keep.
Anything over £30,000 in that qualifying pot is subject to Income Tax at your marginal rate. You do not pay Class 1 NICs on the excess, though your employer pays Class 1A NICs on it.9GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On
Two categories escape tax entirely regardless of the £30,000 cap: payments made because an injury, illness, or disability stops you continuing in the role, and legal costs your employer pays directly to your solicitor in connection with a settlement.9GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On
PILON Inside a Settlement Agreement
Settlement agreements don’t change the tax treatment of notice pay. If you aren’t working your notice, the PENP formula still applies to the notice-pay element and that portion is taxed as earnings, whether or not the agreement labels it a PILON. There is no way to structure around it.
Once the PENP amount and anything else that counts as earnings (unpaid wages, holiday pay, payments for restrictive covenants) have been stripped out and taxed, the balance of the settlement can fall under the £30,000 exemption.9GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On That is why a solicitor reviewing a settlement will itemise every line: each payment’s tax treatment depends on which bucket it belongs in.
If You’re Dismissed for Gross Misconduct
Summary dismissal for gross misconduct means you leave immediately with no notice entitlement. With no notice period, there are no unworked notice days, so PENP produces nothing to tax on that basis. The employer still owes you accrued pay, holiday, and expenses, which are taxed as normal earnings. Any separate compensation payment made despite the misconduct dismissal would be assessed under the £30,000 exemption rules, because there was no notice pay to buy out.
If You Think the Calculation Is Wrong
Check the figures. Run the PENP formula using your own payslip for BP, the correct unworked notice days for D, and your pay period length for P. Compare the result to what has been deducted on your P45 or final payslip. If PENP has been overstated, you may have overpaid tax on your termination payment, and overpaid amounts can be reclaimed from HMRC. If it has been understated, HMRC can pursue the shortfall from the employer, with penalties and interest attached.10GOV.UK. Penalties – An Overview for Agents and Advisers Either way, the time to look is now, while the paperwork is fresh and the figures can still be traced.