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Calculating ETP tax withholding rates as part of final pay

When paying employment termination payments, employers need to be mindful of the tax rules.

Employment termination payments (ETP) are paid as a lump sum from an employer to an employee after employment has terminated. These typically form part of an employee’s final pay and include things like gratuities and severance pay. In addition to ETP, employers may also need to provide employees with an employment separation certificate.

The Australian Taxation Office (ATO) has outlined specific requirements that employers need to meet for ETP. This includes the classification of an eligible termination payment, payment methods, timings and ETP tax. All of these should be included an ETP payment summary when calculating final pay after the termination of employment.

In particular, employers should be mindful of the taxation of termination payments, as the withholding rates differ from an employee’s regular income.  ETP tax is a specific tax rate for any eligible termination payment and is made up of a taxable and tax-free component. Both need to be factored into final pay after resignation or termination.

What is the concessional ETP tax rate?

What is ETP, and how is termination pay calculated and taxed? Generally, employers need to pay the net amount of cash payment to employees. This is the gross amount after any withheld amounts have been deducted.

ETP tax withholding rates vary depending on the type of payment, how employment was terminated and the employee’s age.

In line with Australian taxation laws, termination payments are concessionally taxed up to a limit, which is also known as an ETP cap. Any amount that exceeds these caps are taxed at the top rate.

What is an ETP cap? There are two caps currently in effect:

  • A whole-of-income cap of $180,000, which is reduced by any other taxable payments received by the employee in the same income year. This can include salary and taxable components of earlier ETPs.
  • An ETP cap, which is indexed each year and reduced by any earlier ETPs that were paid in the same year or by earlier ETPs from the same termination. The indexed cap for 2019 to 2020 is $210,000.

The ETP tax rate and cap used depends on the type of payment. To help employers, the ATO has a detailed guide which outlines the rates and caps that apply for each ETP. Regardless of which cap it falls under, the top tax rate applies for any payments that exceed the low rate cap. 

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What is the concessional ETP tax rate for high-income earners?

ETPs are generally taxed at a lower rate than an employee’s regular income as a result of the low rate cap. The top marginal rate only applies to amounts above the cap.

High-income earners are subject to additional rules. Any taxable component of the ETP below $180,000 is taxed either at 16.5% or 31.5%, depending on the type of payment. Any amount that exceeds $180,000 is taxed at the top marginal rate of 46.5%.

ETP tax for life benefit and death benefit termination payments

Employers need to bear in mind that life benefit termination payments and death benefit termination payments are subject to different taxation rules.

In the case of a life benefit termination payment, the taxable component is taxed at ordinary tax rates. However, employees may be eligible for a tax offset which puts an upper limit on the tax withheld, depending on their age:

  • If the employee is 55 or over, the tax withheld cannot exceed 16.5% on the amount up to the low rate cap.
  • For employers under the age of 55, the tax withheld cannot exceed 31.5% up to the low rate cap. 

Regardless of age, any amount over the low cap rate is taxed at the top marginal rate. This tax rate generally applies to each ETP an employee receives.

For the death benefit payment, the tax rate varies depending on who the payment is made to:

  • If the payment is made to a dependant of the deceased employee, no tax is withheld from the tax-free component. This also applies to the taxable component, provided it is within the low rate cap range.
  • If the payment is made to a non-dependant, no tax is withheld on the tax-free component. Any amount up to the low rate cap is taxed at 31.5%. Any amount that exceeds this is taxed at the top marginal rate.

Lastly, if an employee has not provided a Tax File Number (TFN), the employer is required to use the top marginal rate when withholding tax on an ETP.

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