Tax-Free Termination Payments: The £30,000 Threshold and PENP

In the UK, the first £30,000 of a termination payment is tax-free, provided the money genuinely compensates you for losing your job rather than paying you for work you already did or rights you already held. The exemption sits in Section 403 of the Income Tax (Earnings and Pensions) Act 2003, and it operates as a single cumulative cap across every payment linked to the same employment.¹ Anything above £30,000 is taxed as income at your marginal rate, and several common items in a final pay packet never reach the exemption at all.

How the Threshold Works

Section 401 of ITEPA 2003 catches any payment or benefit received in connection with the end of your employment, a change in your duties, or a change in your earnings.² Once a payment falls within that scope, Section 403 exempts the first £30,000.¹

The £30,000 is a per-employment cap, not a per-payment allowance. If your employer makes several termination-linked payments on different dates or across different tax years, they are aggregated against the same limit.¹ Splitting the package into instalments does not reset it.

Section 401 is also residual. If a payment can be taxed under any other provision first, it is taxed under those rules and never touches the exemption.³ That single point drives most of what follows.

What Qualifies for the Exemption

Statutory and Enhanced Redundancy Pay

Statutory redundancy pay counts in full toward the tax-free £30,000. Enhanced redundancy pay — a voluntary top-up above the statutory minimum — also qualifies, so long as the extra is genuinely discretionary rather than a contractual entitlement written into your terms of employment.⁴ If the higher amount was always guaranteed by your contract, HMRC can treat it as earnings.

Ex-Gratia Payments

An ex-gratia payment is a voluntary sum offered without any legal or contractual obligation. These commonly appear in settlement agreements as compensation for the loss of the job and sit within the £30,000 exemption. The distinguishing feature is that you had no pre-existing right to the money. If the payment was guaranteed in your contract, even informally, HMRC may treat it as taxable earnings instead.

Non-Cash Benefits

Keeping company property after your employment ends — a laptop, phone, or car — can count as a termination benefit. The market value is aggregated with any cash payments against the same £30,000 cap.⁴

What Never Qualifies

Section 62 of ITEPA 2003 defines earnings broadly to include salary, wages, fees, gratuities, and other benefits obtained from the employment.⁵ Anything falling in that definition is taxed as earnings and never reaches the exemption. In practice, that means:

Outstanding salary and wages for your final days or weeks of work.
Accrued holiday pay for annual leave you did not take. You would have received the money had you taken the holidays.
Bonuses and commissions earned during your employment. These reward services, not the loss of the job.
Arrears of pay from earlier in your employment, whenever they are actually paid.

Payroll is meant to strip these out before applying the £30,000 threshold to what is left. Misclassification cuts both ways: sometimes qualifying compensation is wrongly run through PAYE as earnings, and sometimes taxable earnings are wrongly slipped under the exemption.

Post-Employment Notice Pay

The biggest carve-out from the exemption is Post-Employment Notice Pay. Since April 2018, employers must calculate PENP whenever someone leaves without working their full notice period.⁶ PENP is the portion of a lump-sum termination payment that effectively replaces the notice period you did not serve. It is taxed as normal earnings and cannot shelter under the £30,000 exemption, even where the wider package is otherwise qualifying.

The formula, set out in Section 402D of ITEPA 2003, is:⁷

((BP × D) ÷ P) − T

BP is your basic pay in the last pay period before the trigger date (usually the date notice was given or the termination date, whichever is earlier).
D is the number of calendar days of your notice period that you did not work.
P is the number of calendar days in that last pay period.
T is any other taxable termination payment already treated as earnings, such as a contractual payment in lieu of notice.

If the formula produces a negative number, PENP is treated as zero. If it exceeds the total termination award, PENP is capped at that total.⁷ Check the PENP figure before assuming the balance of your termination payment falls under the £30,000 threshold. Errors in the BP variable are common where overtime or variable pay is involved.

What Tax You Pay on the Excess

Any amount over £30,000 is added to your other income for the tax year and taxed at your marginal rate. For England, Wales, and Northern Ireland in the 2025-26 tax year:⁸

Basic rate of 20% on taxable income up to £37,700 above the personal allowance.
Higher rate of 40% between £37,701 and £125,140 above the personal allowance.
Additional rate of 45% above £125,140.

The personal allowance is £12,570 but tapers away once total income passes £100,000 and disappears completely at £125,140.⁹ A large termination payment stacked on top of your regular salary can push you into a higher band for the year or trigger the allowance taper, so the tax year in which the payment lands matters. Scotland has its own bands and rates.

You do not pay employee National Insurance on any part of a termination payment, including the taxable excess. Employers do pay Class 1A NICs at 13.8% on the amount above £30,000 that has not already gone through Class 1 NICs on payroll.¹⁰ That cost sits with the employer but sometimes affects how gross and net figures are negotiated.

Your employer runs the taxable portion through payroll and deducts income tax under PAYE.¹¹ If the payment arrives after your P45 has been issued, an “0T” code is applied, which assumes your personal allowance is already used up and often produces heavier deductions upfront. Self-assessment reconciles the position at year end and can produce a refund if too much was taken at source.

Injury, Disability and Discrimination Payments

Section 406 of ITEPA 2003 provides a separate, uncapped exemption for termination payments made on account of injury or disability. Compensation for a physical or psychiatric condition that prevents you from doing your job sits outside the normal termination rules entirely and is not limited by the £30,000 cap.¹²

Two limits apply. HMRC will expect medical evidence that the condition genuinely stops you from carrying out your duties; a vague reference to stress will not carry it.¹³ And the statute expressly excludes injured feelings, so compensation for hurt pride or embarrassment alone does not qualify.¹² A diagnosed psychiatric condition such as clinical depression or an anxiety disorder that impairs your ability to work can qualify where medical evidence supports it. Payments connected to an employee’s death during employment are also fully exempt under the same provision.

Discrimination compensation sits somewhere different. Where the discriminatory act occurred during employment and is unconnected to the termination itself, HMRC generally accepts that the payment falls outside Section 401 and is not taxable. Where the discrimination is the termination — you were dismissed because of a protected characteristic, for example — the compensation is connected to the termination, falls within Section 401, and counts toward the £30,000 threshold. The tax treatment of an injury-to-feelings award turns almost entirely on which of those two the discrimination is characterised as.

Settlement Agreements and the Tax Indemnity

Most termination packages of any size are documented through a settlement agreement. For the agreement to bind you, you must receive independent legal advice, and the adviser must sign a certificate confirming they have explained the terms and their effect on your ability to pursue claims. Your employer usually contributes toward the cost of that advice.

A properly drafted settlement agreement splits the total package into its parts: taxable earnings (salary, holiday pay, bonus, PENP) and qualifying termination compensation eligible for the £30,000 exemption. It will normally include a tax indemnity, a clause making you personally responsible for any additional tax if HMRC later decides a payment was misclassified. The indemnity is standard, but it means the classification matters to you and not just your employer. If your solicitor does not walk you through how each line is taxed, ask.

Practical Checks Before You Sign

Ask for a line-by-line payment breakdown separating taxable earnings from qualifying termination compensation. If your agreement does not show that split, request it.
Confirm the PENP calculation, especially the basic pay figure used. This is where numbers most often go wrong.
Think about the tax year. If timing is flexible, receiving the payment in a year where your other income is lower can reduce the marginal rate on the taxable excess and may protect your personal allowance from the taper.
Use the funded legal advice for tax, not just employment law. The solicitor should be able to explain the treatment of every line.
Read the tax indemnity carefully. If HMRC later reclassifies part of the payment, you pay the bill.

1
legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 403
2
legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 401
3
HM Revenue & Customs. Employment Income Manual – EIM13000 – Termination Payments and Benefits: Section 401 ITEPA 2003: General
4
GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On
5
legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 62 – Earnings
6
GOV.UK. Changes to the Treatment of Termination Payments and Post-Employment Notice Pay for Income Tax
7
HM Revenue & Customs. Employment Income Manual – EIM13880 – Post-Employment Notice Pay Formula
8
GOV.UK. Income Tax Rates and Allowances for Current and Previous Tax Years
9
GOV.UK. Income Tax Rates and Personal Allowances
10
GOV.UK. 2026 Class 1A National Insurance Contributions on Benefits in Kind, Termination Payments and Sporting Testimonial Payments
11
GOV.UK. Tax on Termination Payments – How Tax and National Insurance Are Deducted
12
legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 406
13
HM Revenue & Customs. Employment Income Manual – EIM12965 – Termination Payments and Benefits