Is pay in lieu of notice taxed?

Yes. Pay in lieu of notice (PILON) is taxed as earnings, so you pay Income Tax and National Insurance on it as if you had worked the notice. GOV.UK says this covers any payments you receive instead of working during your notice period, and pay you are given while on gardening leave. It does not get the £30,000 tax-free treatment that some redundancy payments get, though a related rule can drag part of a severance payment into tax.

What counts as pay in lieu of notice

When you leave, you are normally entitled to notice, or to be paid for it. If your employer asks you not to work some or all of it and pays you a lump sum instead, that is PILON. If you stay on the payroll but are asked not to work, that is gardening leave, and the pay is treated the same way. Notice entitlements are in notice periods.

GOV.UK lists what you pay tax and National Insurance on in a termination payment: unpaid wages, holiday pay, bonuses, payments for agreeing to a restrictive covenant, and any payments you get instead of working your notice period, whether PILON or part of severance pay.

Post-employment notice pay

If you do not work your full notice, you pay tax and National Insurance on the part of your termination payment equal to what you would have earned if you had worked. This is post-employment notice pay, or PENP. It applies to lump sum PILON, gardening leave pay, and part of any severance, enhanced redundancy or non-cash benefits.

Statutory redundancy pay is outside PENP. HMRC’s examples show how it works. With statutory redundancy of £10,000 and a severance payment of £5,000, someone on £500 a week who did not work a 4-week notice period would have earned £2,000. They pay tax and National Insurance on £2,000 of the severance, and the other £13,000 is under the £30,000 limit. With £1,000 a week the figure is £4,000, and since severance is only £3,000 they pay tax on all £3,000.

Take a third case, using the same logic. Statutory redundancy pay is £10,000 and the employer adds £20,000, so the total is £30,000. You did not work a 4-week notice and earn £500 a week, so £2,000 of the severance is PENP and is taxed with National Insurance. The rest stays inside the £30,000 limit.

So the combined £30,000 tax-free limit for statutory redundancy pay, enhanced redundancy and non-cash benefits is reduced by PENP. Is redundancy pay taxed? covers the £30,000 rule itself.

What is not taxed

You will not pay tax and National Insurance on contributions your employer makes to a registered pension scheme as part of the payment (tax applies to amounts over the Annual Allowance), on legal costs your employer pays directly to your solicitor for the settlement, or on a termination payment because an injury, illness or disability stops you doing your job.

How the tax is deducted

Your employer takes the tax and National Insurance on the taxable parts automatically through PAYE, on your final payslip. If you get your termination payment after you have received your P45, the employer will use a 0T tax code, which assumes you have used up your Personal Allowance for the year. That can take more tax than you will end up owing. If your total income for the year is higher than usual, you may also pay more than usual.

If you file Self Assessment, include the payment as additional information. If you think you paid too much tax, or the payment was taxed wrongly, contact HMRC. The wider picture of what happens to your tax when you leave is in tax when you leave a job.

A hypothetical example

Say you earn £600 a week and your employer ends your job with immediate effect, paying a lump sum of 8 weeks’ notice, £4,800. That sum is PILON. It goes through payroll in the same way as wages, with tax and National Insurance deducted, and appears on your final payslip. GOV.UK’s guidance treats it as earnings.

If you are unsure how a figure was built up, ask payroll for a breakdown. Acas gives free advice on disputes about what you are owed.