Often a consideration when an employee is ceasing their employment is what are the tax implications on both the receipt and payment of lump sums in respect to their departure. This can be a consideration for payments made to regular employees and also to directors of companies when their employment is being terminated.

Section 112(1) TCA 1997 provides that income tax under Schedule E is charged on an individual having or exercising an office or employment in respect of “all salaries, fees, wages, perquisites or profits” from the office or employment. As such, in the first instance, any payment of a sum to an employee would come within the scope of Schedule E. However, there are certain payments in respect of the termination of employment which may be exempt from this tax treatment. We have provided a brief overview below of some key items to keep in mind when you are advising your clients on the tax implications of payments to exiting employees & directors.

Pay In Lieu of Notice

In circumstances where the contract of employment between employer and employee provides for a payment in lieu of notice under the contract, then this payment will be taxable under Section 112 TCA 1997 as emoluments arising from an office or employment. In circumstances where there is no such contractual obligation, there is potential scope (depending on circumstances) for this payment to be treated as an exempt payment for the employee.

Statutory Redundancy

As provided for in Section 203 TCA, statutory redundancy payments are exempt for income tax purposes and also are not taxable emoluments for PRSI or USC purposes. An ex-gratia tax free termination payment can be paid on top of this payment, if the employer so desires. An individual is entitled to a minimum redundancy payment after 2 years of service in their employment. This entitlement is two weeks' pay for every year of service and an additional week’s pay. The maximum amount used to calculate redundancy pay is €600 a week. A Class S PRSI contributor has no entitlement to statutory redundancy.

Holiday Pay

A payment for accrued annual leave on the cessation of employment will be treated as income for the purposes of Schedule E as normal.

Retraining Payments

Where an employer pays for retraining as part of a redundancy package this cost can be an exempt payment where the employee has more than two years of service, the retraining is part of a redundancy package, it is aimed at improving skills to obtain a new job or set up a business, the training is completed within 6 months and the cost does not exceed €5,000.

Exemptions and reliefs under Section 201 & Schedule 3 TCA 1997

Basic Exemptions, Increased Basic Exemptions & Standard Capital Superannuation Benefit (SCSB)

Where a lump sum payment is paid to an exiting employee (or director) and this payment is not provided for contractually, then the payment would be considered an ex-gratia discretionary payment from the employer to the employee, and the following potential exempt amounts could be considered:

Basic Exemption: Under the basic exemption an ex-gratia payment of €10,160 plus 765 per full year of service can be paid tax free.

Increased Basic Exemption: Under the increased basic exemption, the basic exemption amount can be paid and this can be increased by a maximum of €10,000. This €10,000 increase is reduced where there exists an entitlement to a lump sum from an occupational pension scheme for that employer. The increased basic exemption only applies where the employee has not in the previous 10 years claimed relief in excess of the basic exemption.

SCSB: Under this option, the tax-exempt amount is 1/15 of the average annual pay for the last 36 months multiplied by the number of full years of service. This amount is reduced where there exists an entitlement to a lump sum from an occupational pension scheme for that employer.

The above exempt amounts are not subject to income tax, PRSI or USC. Any payments in excess of the exempt limits will be taxable for the employee and subject to income tax and USC. The excess is not subject to PRSI. There is a lifetime limit of exempt payments of €200,000.

Pension Contributions

Often, it is considered whether pension contributions should or can be paid to an employee (or director) on ceasing their employment. A company can make pension contributions for both directors and employees. Depending on particular circumstances and pension types (e.g. occupational or PRSA etc.), pension contributions can be paid into a pension fund tax-free. From a company perspective, the company could look to get a tax deduction for this in its tax computation (spread over a number of years or potentially in one year, depending on specific circumstances). From 01 January 2025, there is an employer limit of 100% of the employee’s salary in respect of employer contributions to an employee’s PRSA. Any contributions in excess of this limit will be treated as a benefit in kind (BIK). There are also salary sacrifice rules which need to be assessed.

An important area to review prior to any employment termination

In circumstances where your clients have employees/directors leaving their employment, or they themselves are exiting their employment, the above should be considered in advance of any such cessation to assess the tax implications of any proposed payments or to advise on what potentially tax-efficient payments can be made. This is important from both the employee/director’s perspective and the employer’s perspective. The above payments discussed generally should be tax deductible for the employer, however, where the trade of the employer is ceasing, this could impact the tax deductibility of certain payments.

Payments to employees and directors is an area of increased scrutiny by Revenue and therefore it is always important to ensure tax compliance in respect of payments to exiting employees or directors to ensure there is no risk exposure for unpaid / underpayments of payroll taxes.

Navigating the tax implications of payments to exiting employees and directors can be complex, and ensuring compliance while maximising tax efficiencies is crucial. If you have any uncertainties or need guidance on a specific case, our OmniPro Tax & Legal team is here to assist. We can help you and your clients structure termination payments in a tax-efficient and compliant manner. Do not hesitate to reach out - we are happy to support you.

The contents of this article are meant as a guide only and are not a substitute for professional advice. The author/s accept no responsibility for any action taken, or refrained from, as a result of the material contained in this document. Specific advice should be obtained before acting or refraining from acting, in connection with the matters dealt with in this article. The information at the time of publishing was accurate and could be subject to final changes.