An employment termination payment is generally a lump sum amount paid to an employee upon termination of their employment. Depending on the type of employment termination payment, the employee’s age and years of service, the amount may be taxed in a number of different ways. However we have noticed there are some common mistakes made when calculating an employee’s termination payment, such as:
- Incorrect tax rates applied
- Incorrect hourly rate used to calculate entitlements
- Superannuation being paid on accrued leave balances paid out
- Superannuation is not paid on notice period paid in lieu
- Leave loading (where applicable) is not paid out on accrued leave
- Payments as a result of employees invalidity or death
The taxation of termination payments is a minefield. The tax rate applied to differing components of a termination payment can depend on:
- Age of the employee at termination
- Reason for the termination – e.g. resignation, redundancy, genuine retirement
- The employee’s length of service
When calculating an employee’s entitlement to long service leave upon termination, the ordinary rate of pay should be used. This excludes allowances, shift loadings, penalties and overtime.
The minimum superannuation guarantee charge is paid on an employee’s ‘ordinary time earnings’ or OTE. OTE are generally what an employee earns for their usual hours of work, and include:
- Over-award payments
- Some bonuses
- Shift loading
- Certain allowances – generally those that are not considered a reimbursement of expenses
- Lump sum annual leave, long service leave and sick leave paid on termination are excluded from OTE.
When terminating an employee and an employer makes the decision to pay them in lieu of notice (instead of the employee working this period), this notice period amount is subject to the superannuation guarantee charge. It is one of the few payments paid on termination that qualify as ordinary time earnings.
Some employees are entitled to leave loading on annual leave per their Award or employment contract. Upon termination, leave loading should still be included in the calculation of lump sum annual leave even if the Award or contract specifically state it is not payable. This is in accordance with the Fair Work Act.