Are settlement agreements taxable?
Partly. Up to £30,000 of a genuine termination payment made under a settlement agreement is free of income tax and National Insurance under sections 401 to 403 of the Income Tax (Earnings and Pensions) Act 2003. Everything else in the package, including salary, holiday pay, bonuses and payment in lieu of notice, is taxed as normal income on top of that allowance.
What counts as tax-free, and what doesn't
The £30,000 exemption in sections 401 to 403 ITEPA 2003 applies to a genuine compensation-for-loss-of-employment element, typically labelled an "ex gratia" payment in the agreement. It does not extend to anything you were already contractually owed: unpaid salary, accrued holiday pay, contractual bonuses and payment in lieu of notice (PILON) are all taxed as earnings in full, on top of the £30,000 allowance, not from within it.
Since April 2018, PILON is taxable from the first pound under the post-employment notice pay (PENP) rules in section 402D ITEPA 2003, whether or not your contract had a PILON clause. Only the amount above the PENP figure can potentially fall inside the £30,000 exemption. See our payment in lieu of notice guide for how that interacts with the rest of a settlement package.
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