Recent events have resulted in some employers cutting back on staff numbers. When a client’s employment has been terminated it is important to be aware of the implications that will impact their financial situation and the appropriate strategy moving forward, including the taxation of payments, the potential impact on other income tested benefits, access to superannuation, as well as the implications for social security benefits.
Termination payments
Common types of payments someone receives on termination of employment include:
- Outstanding salary, wages and other remuneration owing
- Accrued annual and long service leave
- Pay in lieu of notice
- Redundancy payment
The tax treatment of these payments varies depending on the type of payment, the reason employment was terminated and the circumstances of the individual.
In this article we focus on payments that are made due to genuine redundancy. For genuine redundancy to occur, certain conditions must be met, such as the individual’s employment must have ended due to their position being genuinely redundant, the payment must be greater than it would be had they ceased work voluntarily, and there must be no arrangement between the employee and the employer for the employee to return to employment with the employer. In addition, the dismissal needs to occur before the earlier of:
- The employee reaching their age pension age (prior to 1 July 2019, the dismissal needed to occur before the individual reached age 65), and
- If the employee’s employment would be terminated at a specific age or after a specific period of service – that age or before the end of the period of service.
Taxation of payments
Outstanding salary and wages will be treated as they ordinarily would be, had the person’s employment continued. These payments will generally be included in the person’s assessable income.
The taxation of lump sum annual and long service leave payments is dependent on the reason for the termination of employment and the individual’s service period. Where the payment results from genuine redundancy and the individual’s service does not pre-date 16 August 1978, the whole amount is included in the individual’s assessable income and a tax offset is applied to limit tax to a maximum rate of 30 per cent. Leave payments are also subject to Medicare Levy.
Example
Jacob is age 50. His employment is terminated due to genuine redundancy and he has the following income for 2020-21:
| Salary | $45,000 |
| Lump sum annual leave | $20,000 |
Jacob's tax position will be as follows:
| Assesable income | $65,000 |
| Allowable deductions | $ Nil |
| Taxable income | $65,000 |
| Tax on taxable income | $11,592* |
| Tax offset on annual leave | ($500)^ |
| Net tax | $11,092 |
* Salary uses both the tax-free threshold and the 19 per cent marginal tax rate. Annual leave subject to 32.5 per cent marginal tax rate.
^ Tax offset on annual leave is difference between the marginal tax rate (i.e. 32.5 per cent) and the maximum rate of 30 per cent.
Employers have an obligation to withhold tax at the relevant maximum tax rate. The client may claim a credit for tax withheld by the employer when they lodge their tax return. Due to this withholding, the client won’t be liable for any additional tax on these payments when their income tax return is lodged.
Genuine redundancy payment
Broadly speaking, the genuine redundancy payment will be the amount of the payment that exceeds the amount the employee would ordinarily receive had they voluntarily terminated their employment.
The genuine redundancy payment can be broken down into the following two components:
- The tax-free amount (based on years of service), and
- The employment termination payment (ETP).
The tax-free amount for 2020-21 is calculated using the following formula:
Tax free = $10,989 + $5,496 fpr every completed year of service
The tax-free amount is not included in assessable income and therefore won’t affect the client’s tax position. The taxation of the ETP depends on the components of the ETP, the individual’s age at the end of the relevant financial year and whether the ETP exceeds a threshold, known as the ETP cap amount. The ETP cap amount is $215,000 for the 2020-21 income year, and is indexed each year.
The following table summarises the taxation of ETPs.
| Age at end of financial year | Tax-free component | Taxable component |
| Under preservation age (refer to table below) | Non-assessable non-exempt income | Maximum rate of 30%* up to cap 45%* above cap |
| Preservation age and over (refer to table below) | Non-assessable non-exempt income | Maximum rate of 15%* up to cap 45%* above cap |
*Plus Medicare levy
Preservation age
Date of birth from | to | Preservation age |
|---|---|---|
| 30 June 1960 | 55 | |
| 1 July 1960 | 30 June 1961 | 56 |
| 1 July 1961 | 30 June 1962 | 57 |
| 1 July 1962 | 30 June 1963 | 58 |
| 1 July 1963 | 30 June 1964 | 59 |
| 1 July 1964 and later | 60 |
As shown above, an ETP is comprised of the tax-free component and the taxable component.
The tax-free component of the ETP can arise in the following scenarios:
- The person ceases work due to invalidity, and/or
- The person has pre 1 July 1983 service with their employer.
The tax-free component of the ETP is not included in assessable income and therefore won’t affect the client’s tax position.
The taxable component of the ETP is:
Taxable component = Value of ETP – tax-free component of ETP
The taxable component of the ETP is included in the client’s assessable income. Amounts up to the ETP cap amount receive a tax offset to limit tax to the maximum rate. The amount of the taxable component that exceeds the ETP cap amount is taxed at the highest marginal tax rate.
The ETP cap amount is an annual cap, not a lifetime cap. It is reduced by the taxable component of any ETP received in the same income year and the taxable component of any ETPs that relate to the same termination of employment.
Effect on other benefits and strategies
As noted above, some portions of termination payments will be included as assessable income. This may impact certain other benefits and strategies where assessable income is incorporated into the income test. Tests affected by assessable income include:
Benefit/strategy | How assessable income affects eligibility |
| Spouse contribution tax offset | Test includes assessable income |
| Government co-contributions | Test includes assessable income |
| Low income super tax offset | Test includes assessable income |
| Division 293 tax on concessional contributions | Test includes taxable income* |
| Low income tax offset | Test includes taxable income* |
| Low and middle income tax offset | Test includes taxable income* |
| Seniors and Pensioners Tax Offset | Test includes taxable income* |
| Family tax benefits | Test based on adjusted taxable income** |
| Child care subsidy | Test based on adjusted taxable income** |
* Taxable income = Assessable income less allowable deductions
** Adjusted taxable income incorporates taxable income (which is based on assessable income)
Further details of these tests can be found in the Big Black Book and Little Black Book.
Example
Jade’s employment was terminated on 31 December 2020 due to genuine redundancy. Her income and remuneration for the year is:
Current scenario | If employment had continued | |
| Salary for 6 months | $100,000 | $200,000 |
| Rental income | $10,000 | $10,000 |
| Lump sum leave (all assessable) | $10,000 | |
| ETP (taxable component) | $150,000 | |
| Tax Deductions | ($5,000) | ($5,000) |
| Taxable income | $265,000 | $205,000 |
| Add Employer super contribution (SG) | $9,500 | $19,000 |
| Division 293 income | $274,500 | $224,000 |
As can be seen from the table above, if Jade’s employment had continued, her income for division 293 tax purposes would be $224,000. As this is under the $250,000 income threshold, she would not be liable for the additional 15 per cent tax on her concessional contributions.
Despite Jade’s employment ending mid-way through the year, the leave and ETP have increased Jade’s assessed income to $274,500. Division 293 tax applies to the relevant concessional contributions to the extent that they exceed the $250,000 threshold when combined with other assessed income, including taxable income. As all of Jade’s concessional contributions exceed the $250,000 income threshold when combined with her taxable income, she will be liable for the additional 15% tax on her concessional contributions of $9,500 (ie $1,425). As a result of this additional tax, the tax effectiveness of making additional concessional contributions is reduced.
Consider the effect of Jade making a personal tax deductible contribution to super. The effective tax rate for these contributions is 30 per cent inclusive of the division 293 tax. Therefore, for this strategy to be tax effective, the value of the deduction will need to be greater than 30%. The highest rate of tax Jade will be subject to is 32.5 per cent, resulting in a benefit of 2.5 per cent for the contributions she makes. Depending on Jade’s circumstances, she may be better placed delaying the deductible contribution until a future year. This would be applicable where Jade was eligible to use the unused concessional cap for 2020-21 in a future year under the carry-forward of concessional contribution rules and the difference between the tax saved on making the contribution and taxation of the contribution is greater than 2.5%.
Social security considerations
The termination payments received by a client may affect the time at which they will first be eligible to receive social security payments and the amount they will receive. The effect the termination payments have will vary depending on the type of social security payment being applied for.
The Jobseeker payment (known as Newstart allowance prior to March 2020) may be available for those below age pension age. Those applying for the Jobseeker payment may have their payments delayed and/or reduced as a result of the following:
- Income maintenance period (IMP)
- Liquid assets test waiting period (LAWP)
- Means testing based on how the termination payments are invested
Other waiting periods that affect the Jobseeker payment include the compensation preclusion period and the seasonal work preclusion period.
In addition to the above, the ordinary waiting period of one week that usually applies to Jobseeker applicants has been waived until 31 March 2021 by the Government in response to the coronavirus pandemic.
1. Income maintenance period (IMP)
The IMP is not technically a waiting period however it may result in a period of non-payment. When employment is terminated, the length of the income maintenance period is calculated by adding together:
- The number of weeks (or days) that the leave payments represent
- The number of weeks that the portion of the termination payment based on the employee's wage (e.g. 2 weeks redundancy payment for every year of service) represents, and
- The number of weeks that the portion of the termination payment not based on the employee's gross wage (e.g. a gratuity payment) represents. This is obtained by dividing that portion of the termination payment by the relevant weekly wage (and then rounding down this figure to a whole week figure. A 5 day working week is used.
The value of the termination payments is then treated as ordinary income for the length of the income maintenance period.
The IMP generally starts from the date the employer pays the termination payments.
2. Liquid assets test waiting period (LAWP)
The LAWP is a period that precludes a Jobseeker payment applicant from receiving benefits. The LAWP applies where liquid assets exceed a threshold. The formula for calculating the LAWP calculates the number of weeks the person is precluded from receiving benefits and is outlined below.
Liquid assets include cash and other assets that are readily accessible. Common types of liquid assets include cash, shares, term deposits and payments due to be paid by the person’s last employer. It also includes superannuation monies that are unrestricted non-preserved and are therefore accessible, as well as funds held in a mortgage offset account. Funds available via redraw from a mortgage are not considered liquid assets.
The formula for the liquid assets waiting period calculates the number of weeks the waiting period applies. The formula for calculating the LAWP is:
| Single and no dependants: | Liquid assets - $5,500 $500 |
| Partnered or single with dependants: | Liquid assets - $11,000 $1,000 |
Points to note regarding the LAWP:
- The LAWP is rounded down to the nearest whole number of weeks.
- The maximum LAWP is 13 weeks.
- Where the calculation results in a period of less than one week, no LAWP applies.
The IMP and LAWP are served at the same time. Where the LAWP commences before the termination payments are made by the employer, the IMP is considered to have commenced at the same time as the LAWP rather than when the termination payments are paid.
Example
Daniel is single without dependants and has just been made redundant. He received the following payments on termination of employment:
- Lump sum annual leave of $12,000 (equal to 6 weeks of leave)
- Tax-free redundancy payment of $27,477 (3 full years of service)
- ETP $2,523
Daniel’s ordinary earnings from this employment was $2,000 per week. His tax free redundancy payment and ETP were based on 3 weeks of pay for each year of service. Daniel had worked for his employer for 5 years, resulting in the equivalent of 15 weeks’ pay.
Daniel receives the termination payments on the day his employment ends. After receipt of these payments, Daniel’s liquid assets will be $45,000.
Daniel will be applying for Jobseeker payment and would like to know when he might be entitled to receive payment.
Daniel’s termination payments will be used to determine his IMP, calculated as follows:
| Leave payment | 6 weeks |
| Tax free redundancy plus ETP | 15 weeks |
| Total | 21 weeks |
The total payments of $42,000 will be treated as ordinary income over the 21 week IMP and Daniel will therefore be assessed as receiving $2,000 per week during the IMP. For single people without dependent children, the income test cut out for JobSeeker payment is currently $1,257.50. As Daniel’s income during the IMP is greater than this, he will not receive a JobSeeker payment during this period.
Daniel’s LAWP is calculated as follows:
= $45,000 - $5,500
$500
= 79 weeks
The calculated LAWP of 79 weeks exceeds the maximum LAWP of 13 weeks. Therefore, the upper limit of 13 weeks will apply.
As the IMP and LAWP are served concurrently, Daniel will be precluded from receiving a JobSeeker payment until the end of the 21 week IMP.
Access to superannuation
Gaining access to superannuation benefits may be a strategy for helping clients meet their income needs.
One condition of release that may be available is the retirement condition of release.
For those who have reached preservation age and are under age 60, the retirement condition of release is met where an arrangement under which the member was gainfully employed has come to an end and the person never intends to become gainfully employed for at least 10 hours each week. Importantly, the cessation of the arrangement of employment may have occurred at any time, including prior to preservation age.
Those who are age 60 and over are considered to have met the retirement condition of release if either of the following are met:
- An arrangement under which the member was gainfully employed has come to an end and the person never intends to become gainfully employed for at least 10 hours each week (ie same definition that applies from age preservation age and under 60), or
- An arrangement of gainful employment has come to an end and the cessation of this employment occurred after the person had reached age 60.
Under this second option, intention regarding future employment is not relevant.
When the client meets the retirement condition of release, all of their superannuation benefits at that date become unrestricted non-preserved and can be accessed as a lump sum or income stream. Further benefits accrued in an accumulation account after that date will be preserved until a subsequent condition of release is met.
A client who was under 60 may not satisfy the retirement condition of release due to an intention regarding future employment or because they are under preservation age. Alternatively, they may qualify for one of the other conditions of release, such as compassionate grounds (including the new coronavirus option, which ceases on 31 December 2020) or severe financial hardship.
The number of people experiencing a termination of employment has increased as a result of the recent economic downturn. Understanding the financial implications that arise from the termination of employment is an essential component of the financial planning process.