This article examines the tax consequences of receiving a redundancy package and what this may mean for clients.

Upon termination of employment, individuals may be eligible to receive a variety of payments in connection with their termination. Eligibility for such payments will typically be determined by their employment agreement, award or employment contract – and typically based on the employee’s age and/or years of service with the employer.

Whilst few financial planning strategies are available when dealing with termination payments, it’s important to understand the associated tax implications – as this will determine how much money is available for meeting living expenses, subsequent investment, debt re-payment, super contributions or other personal goals.

In this article, we look at the tax consequences of receiving a redundancy package and what this may mean for clients.

Introducing Richard

Richard (age 54) had worked for his employer for 15 years, earning a salary of $105,000 per annum.

Unfortunately, Richard was made redundant from his position effective 20 July 2018 (i.e. during the 2018/19 financial year).

Richard’s employer provided him with the following breakdown (outlined in Table 1) of his redundancy package:

Table 1

Payment type	Gross payment ($)
Unused annual leave	2,000
Unused long service leave	4,500
Severance pay	68,000
Unused sick leave	18,000
Payment in lieu of notice	8,000
Total	$100,500

Note: Richard’s severance pay, unused sick leave and payment in lieu of notice would not have been paid out had he voluntarily resigned from employment.

Taxation of lump sum unused annual leave and long service leave payments

Unused annual leave and long service leave payments received as a lump sum upon genuine redundancy are taxed at concessional rates depending on the accrual period as outlined in Table 2.

Table 2

Accrual period	Annual leave*	Long service leave*
Before 16 Aug 1978	Maximum rate of 30%	5% taxed at marginal tax rate
On or after 16 Aug 1978		Maximum rate of 30%

* plus Medicare levy of 2%.

Importantly, the above rates do not apply if the employee is age 65 or over at the time their employment ceases. This is because the termination of employment of a person age 65 or over is not considered to be due to ‘genuine redundancy’ (see later).

Instead, unused annual leave and long service leave in this situation will be taxed in the same way as leave payments received following voluntary resignation/retirement, as outlined in Table 3.

Table 3

Accrual period	Annual leave*	Long service leave*
Before 16 August 1978	Maximum rate of 30%	5% taxed at marginal tax rate
16 August 1978 to 17 August 1993		Maximum of 30%
On or after 18 August 1993	100% taxed at marginal tax rate	100% taxed at marginal tax rate

* plus Medicare levy of 2%.

Richard’s lump sum unused annual leave and long service leave payments

The tax on Richard’s lump sum unused annual leave and long service leave payments is shown in Table 4.

Table 4

Payment type	Gross payment ($)	Maximum tax rate	Maximum tax payable ($)	Net proceeds ($)
Annual leave	2,000	32%	640	1,360
Long service leave	4,500	32%	1,440	3,060
Total	$6,500		$2,080	$4,420

Richard will need to include the gross payments of $6,500 as assessable income in his 2018/19 tax return. A tax offset will ensure that he pays no more than 32 per cent tax on these payments.

As these leave payments are included in Richard’s assessable income, this may impact his entitlement to certain tax offsets and concessions, such as the government co-contribution, Low Income Tax Offset (LITO), Low and Middle Income Tax Offset (LMITO), and the Seniors and Pensioners Tax Offset (SAPTO). It is also included as income for the purposes of calculating Division 293 tax (i.e. the additional 15 per cent tax on concessional contributions for higher income earners).

A note about Superannuation Guarantee (SG)

Unused annual and long service leave payments received as a lump sum upon termination of employment are specifically excluded from the definition of an employee’s ‘ordinary time earnings’ (OTE), so an employer is not required to pay SG on such payments.

However, if practical and agreed to by their employer, some clients may choose to ‘go on’ annual and/or long service leave, terminating their employment once the leave is exhausted.

In this scenario, the leave payments will be ordinary assessable income and taxed at the individual’s usual marginal tax rate. Further, as the leave payments will now represent normal salary and wages, SG would be payable on the amounts received.

What is a genuine redundancy payment?

Genuine redundancy occurs where an employee is dismissed from employment because their position is genuinely redundant. In other words, the employee’s position is no longer required by the employer and effectively no longer exists.

For a genuine redundancy payment to exist, the following conditions must be met:

• the redundancy must be genuine;
• the termination of employment must typically occur before the day the employee turns 65;
• the payment cannot exceed the amount payable if dismissal was at arm’s length;
• there must be no arrangement for the employer to employ the individual at a later date; and
• the payment must be more than the amount the employee would have received if they had voluntarily resigned or retired in other circumstances.

Genuine redundancy payments are tax-free up to a limit based on the employee’s completed years of service with the employer. For the 2018/19 financial year, this limit is $10,399 plus $5,200 for every completed year of service.

Tax-free limit only applies to payments on genuine redundancy

In order for part/all of a termination payment to qualify under the tax-free limit, the payment must be specifically attributable to the termination of employment as a result of redundancy. This means that any amount a person would have received upon simply resigning or retiring will not ordinarily form part of the tax-free limit, but will be an employment termination payment (ETP).

Richard’s tax-free amount

To assess the tax consequences of the remaining components of Richard’s redundancy package, we need to determine which of Richard’s payments (other than his unused annual leave and long service leave) will be treated as genuine redundancy payments and thus be eligible to qualify under the tax-free portion.

As Richard would not have received any of these payments if he had voluntarily resigned, the entire $94,000 amount (severance payment + unused sick leave + payment in lieu of notice) is considered a genuine redundancy payment and eligible to qualify under the tax-free limit.

Therefore, the tax-free amount of Richard’s redundancy payment is calculated as follows:

= $10,399 + ($5,200 x 15 years)

= $88,399

This amount will be received tax-free. Further, as it is considered non-assessable non-exempt income, this amount will not need to be included in Richard’s tax return, meaning it will not have any indirect consequences on any other concessions or benefits.

The amount of Richard’s genuine redundancy above his tax-free threshold ($94,000 less $88,399 = $5,601) will be considered an ETP.

Employment termination payments

Broadly, an ETP is a lump sum payment made directly by an employer in consequence of the termination of an employee’s employment.

However, as discussed previously, for tax purposes, ETPs do not include payments for unused annual leave and long service leave or the tax-free part of a genuine redundancy payment.

Importantly, ETPs must be paid in cash. That is, the payment cannot be rolled over to superannuation. However, once the payment is received, the recipient may choose to contribute the after-tax amount into superannuation if they are eligible to do so (and potentially also claim a tax deduction for the contribution if they wish).

Excluded and not-excluded payments

An ETP can be classified as either an ‘excluded’ payment or a ‘not-excluded’ payment. This classification can have a significant impact on tax payable.

Fortunately, in most redundancy situations, the resulting ETP will be classified as an ‘excluded’ payment, as it relates to the individual’s genuine redundancy, and the employee would not have normally received the payment(s) had they voluntarily resigned. The taxation of ‘excluded’ ETPs is outlined below.

‘Not-excluded’ payments are subject to different tax rules upon receipt and are beyond the scope of this article.

Tax on ‘excluded’ ETPs

The tax payable on an ‘excluded’ ETP will depend on the value of the payment, the employee’s service period with the employer and their age.

With a genuine redundancy payment, an ETP will contain a tax-free component if the employee’s service with the employer predates 1 July 1983. This component is received tax-free and is not included in assessable income.

The remainder of the ETP will be a taxable component. The taxation of this amount for the 2018/19 financial year depends on the amount of the payment and the employee’s age as outlined in Table 5.

Table 5

Taxable component
Recipient is under preservation age at end of financial year	First $205,000^	Maximum rate of 30%*
	Balance over $205,000^	45%*
Recipient is preservation age or older at end of financial year	First $205,000^	Maximum rate of 15%*
	Balance over $205,000^	45% *

* plus Medicare levy of 2%.
^ ETP cap (refer to ‘The ETP cap’ section of the article)

The taxable component of an ETP is included in assessable income. It is therefore important to remember that the receipt of such payments may affect an individual’s entitlement to certain tax offsets and concessions, such as government co-contribution, LITO, LMITO and SAPTO. It is also included as income for the purposes of calculating Division 293 tax (i.e. the additional 15 per cent tax on concessional contributions for higher income earners).

The ETP cap

The ETP cap is the maximum amount of employment termination payments a person can receive per annum at concessional tax rates.

Some important points about the ETP cap are:

• The cap for the 2018/19 financial year is $205,000. This cap is indexed to Average Weekly Ordinary Time Earnings (AWOTE) in $5,000 increments.
• This cap is applied on an annual basis. A client can receive more than one ETP in their lifetime at concessionally taxed rates, providing each payment is in respect of a separate termination.
• An individual’s cap must be reduced by other ETPs received earlier in the same financial year (regardless of whether it applies to the same termination or different terminations) and in previous years if relating to the same termination.
• This cap is a separate cap to the superannuation $205,000 low rate cap (2018/19 financial year) that an individual can withdraw as a concessionally taxed lump sum from super once they reach preservation age.

Richard’s ETP

We previously determined that of Richard’s total redundancy payout, only $5,601 would be treated as an ETP – this amount will be an ‘excluded payment’ as it was received due to his redundancy. As Richard’s service with his employer does not predate 1 July 1983, the entire ETP will comprise taxable component.

Richard’s age at the end of the 2018/19 financial year is 54. Because he is under preservation age at that time, Richard’s entire ETP will be taxed at a maximum of 30 per cent plus Medicare levy.

The tax on Richard’s ETP is shown in Table 6.

Table 6

Payment type	Gross payment ($)	Maximum tax rate	Maximum tax payable ($)	Net proceeds ($)
ETP – Excluded Payment	5,601	32%	1,792	3,809

Note: Richard’s ETP of $5,601 will need to be included as assessable income in his 2018/19 tax return and the ATO will ensure (via a tax offset) that no more than 30 per cent plus Medicare levy is payable on this amount.

A summary of the tax payable on Richard’s redundancy package is contained in Table 7.

Table 7

Payment type	Gross payment ($)			Tax ($)	Net proceeds ($)
Unused annual leave	2,000			640	1,360
Unused long service leave	4,500			1,440	3,060
Severance payment Unused sick leave Payment in lieu of notice	68,000 18,000 8,000	Tax-free portion	88,399	0	88,399
		ETP (Excluded Payment)	5,601	1,792	3,809
Total	$100,500			$3,872	$96,628

Strategies to reduce tax upon redundancy

There are very few strategies that can be used to minimise tax payable in respect of a redundancy package.

Deferring payment to a new financial year

If practical and permitted by the client’s employer, deferring the receipt of the redundancy package until the following financial year may be beneficial because:

• the tax rates applying to unused annual leave/long service leave payments and the taxable component of employment termination payments are maximum rates. Therefore, if a client’s marginal tax rate for the following financial year is lower than the maximum rate, a lower rate may apply to the payments;
• deferring payment to a new financial year will result in a larger tax-free portion of the genuine redundancy amount, as the tax-free amount is indexed on 1 July each year; and
• where an ETP is received as part of a redundancy package, the ETP cap is indexed on 1 July each year, thus potentially reducing any tax payable on the ETP.

Defer redundancy until after employment anniversary

If a client’s redundancy date is close to their employment anniversary, consider deferring termination until after the next anniversary. This will increase the tax-free amount of the redundancy payment which is based on completed years of employment.

To achieve this, it may be possible for a terminating employee to go on leave (paid or unpaid).

Defer payment until recipient has reached preservation age at 30 June

A person who receives an ETP (‘excluded payment’) in the financial year where they will be preservation age as at 30 June, will pay a maximum of 15 per cent plus Medicare levy on the taxable component of the ETP.

In comparison, where they have not yet reached their preservation age as at 30 June, they will pay a maximum of 30 per cent plus Medicare levy on the taxable component of the ETP.

Personal deductible contributions

Since 1 July 2017, the ‘less than 10’ rule to qualify for making a personal deductible contribution no longer applies. Therefore, clients who terminate employment and receive taxable payments (even those subject to maximum rates) could benefit from making a personal deductible superannuation contribution to reduce their taxable income and tax payable.

Fabian Bussoletti, Technical Strategy Manager, AMP.

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QUESTIONS

Take the quiz here.

1. Fergus (age 67) was made redundant from his employment on 21 September 2018 where he had worked for 10.5 years. Upon his termination of employment, Fergus’s employer provided him with a genuine redundancy payment of $80,000. How much of this payment will be tax-free?

a. $25,000.

b. Nil.

c. $62,399.

d. $67,599.

 

2. As part of his redundancy package, Dennis (age 60) received an ETP (‘Excluded Payment’) of $25,000 (all taxable component) on 1 August 2018. What is the maximum amount of tax Dennis will pay on this ETP (including Medicare levy)?

a. $4,250.

b. Nil.

c. $8,000.

d. $12,250.

 

3. Lisa (age 32) was made redundant from her employment on 31 July 2018 and received the following payments upon termination of her employment:

– Unused annual leave = $4,000.

– Tax-free genuine redundancy payment = $19,030.

– Employment termination payment (above tax-free redundancy payment) = $3,500.

Which of the following statements is correct in relation to Lisa’s redundancy package?

a. Lisa can roll-over her ETP into superannuation.

b. Lisa’s ETP payment will be taxed at a maximum rate of 30 per cent plus Medicare levy.

c. The tax-free amount of Lisa’s genuine redundancy payment will need to be included as assessable income in her tax return.

d. Lisa will be able to enter into a salary sacrifice agreement just before the termination of her employment, allowing her to salary sacrifice her unused annual leave received as a lump sum into superannuation.

 

4. Which of the following payments received in a redundancy situation would be considered a genuine redundancy payment and eligible to qualify under the tax-free amount?

a. Unused annual leave.

b. Unused long service leave.

c. A payment of sick leave where that leave would have ordinarily been paid out had the employee just resigned or retired.

d. A severance payment where the payment would not have ordinarily been paid out had the employee just resigned or retired.

 

5. As part of her redundancy package, Angelina received a lump sum amount representing her accrued unused annual leave entitlements. Her employer is obliged to pay 9.5 per cent SG on this amount. True or false?

a. True.

b. False.