If you have been made redundant, or will be making a position redundant, it will likely affect your tax obligations. This article will provide some helpful information on what taxes you may be liable to pay or report if your business is making redundancy payments or if you will be receiving them.
General Tax Concessions
Tax concessions on redundancy payments will vary depending on whether the redundancy was genuine or non-genuine. To distinguish between the two, see here.
Genuine Redundancies
In this case, the ex-employee does not owe any tax on redundancy payments they receive, up to a certain threshold. This threshold or the ‘tax-free limit’ defines the maximum amount of money for which the ex-employee does not have to pay tax, on their redundancy payment. The formula to calculate the limit is:
Base amount + (service amount x completed years of service)
As can be seen, there are two elements which help to determine the tax-free limit applying to the ex-employee: the base amount and service amount. These amounts change annually, according to the ATO’s specifications. From 1 July 2018 until 30 June 2019, the applicable base amount is $10, 399 and the service amount is $5, 200.
As for payments which are greater in value than the tax-free amount, the amount of money which exceeds the limit will incur tax obligations. However, it will be subject to lower tax rates than the employee’s normal income. Essentially in this circumstance, the excess money is treated separately as an Employment Termination Payment (ETP). For more information on this, see ‘Tax on ETP’ below.
Example
Janice’s genuine redundancy took place on 14 December 2018, after working for her ex-employer for 1 year. She received $20,000 as a gratuity and a $10,000 severance payment. These are both valid redundancy payments, as explained here. As such, the tax-free limit applies. The limit in Janice’s case is $10,399 + ($5,200 x 1) = $15,599. This means Janice owes $0 tax for $15,599 of the gratuity and severance payment combined. The remaining $14,401 is subject to the same tax as an ETP.
Non-Genuine Redundancies
In this case, the payment is treated as an ETP, the tax treatment of which is discussed further below. However, readers must understand beforehand that tax concessions will only apply here if the payment to the ex-employee was no later than 12 months after termination. There are few exceptions to this rule.
Tax on ETP
Tax-Free Component
There are two situations where part or all of an ETP may be tax-free. One scenario is where employment began before 1 July 1983. The other scenario is where an employee develops a permanent disability.
Taxable Component
Apart from the tax-free component which may apply, the whole amount of money which is treated as an ETP is taxable, but at a lower rate than normal. Indeed, it is taxed at a maximum of 17% if the ex-employee has reached preservation age, or a maximum of 32% if they are below preservation age, up to a certain limit or ‘cap’. The top rate of tax will then apply to any amount in excess of the applicable cap.
As to the issue of which cap applies, it depends on the type of payment made. The ETP cap applies to genuine redundancy payments exceeding the tax-free limit discussed in the section ‘General Tax Concessions’ above. For non-genuine redundancies, the whole-of-income cap generally applies.
In 2018-19, the ETP cap is $205, 000 and the whole-of-income cap is $180, 000. However, the amount of each of these caps and which cap applies can vary significantly based on individual circumstances. This means that calculating the exact capped amount which applies to the ex-employee can become quite complex.
Final Note
Understanding how tax and redundancy payments work is crucial for ex-employees reporting the payments on their tax returns, and for ex-employers who need to calculate, report, and withhold tax. As such, if you are still unsure or are seeking more information on the implications of redundancies, it is advisable to consult an accountant or an employment or taxation lawyer. This is particularly important in cases where some of the redundancy payment is treated as an ETP, given the complexity of tax rules in this area.
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