Choosing the correct lump sum code

Preparing a termination payment is already complex and stressful for both the person receiving the payment, and the person processing it. The latter, because of the complexity in choosing which lump sum component for taxation purposes.

Of course, because it’s payroll and it affects the individual’s tax, we also understand that the complexity of figuring out which category to use in your payroll software can be a bit daunting.

That’s why the Calculator Angels have pulled together a little guide just for you!

The most common Lump Sums are Lump Sum A and Lump Sum D.

Here’s a simple, and quick guide of all those categories!

Lump Sum A – The Leave component of a redundancy

Payment of Annual Leave or unused Long Service Leave. You’ll need to add a Type code “R” (for redundancy). Payments for any other reason, it’s a Type “T”.

Things to note – this category is explicitly for:

1. Unused holiday pay and other leave related payments that was accrued before 18 August 1993;
2. Unused long service leave that was accrued after 15 August 1978, but before 18 August 1993;
3. Unused long service leave accrued after 17 August 1993 or unused holiday pay and other leave related payments, where the amount was paid in connection with a payment that includes (or consists of) either:

• a genuine redundancy payment
• an early retirement scheme payment
• the invalidity segment of an ETP or super benefit.

Lump Sum B: Long Service Leave accrued before 16 August 1978

This component is less useful these days due to the time period, however, it is still relevant for a few employers with long term employees.

You use this component only where long service was accrued before 17 August 1978.

Fun facts: only 5% of this balance is subject to the employee’s marginal rate of tax!

Lump Sum D: Redundancy Payments

No, I didn’t miss Lump Sum C. It doesn’t exist any more. Lump Sum C used to be the component for Payment in Lieu of notice (but not a bona-fide redundancy), classified as an “O” type payment.

A Lump Sum D is the tax free component of a bona-fide redundancy and does not appear on an employee’s tax return. We do, however, have to tell the ATO about the payment via the payment summary.

What’s a bona-fide redundancy?

Is a payment received because the job you were doing is abolished. That is, your employer has made a decision that the job you are doing no longer exists and your employment is to be terminated.

What are the components of a bona-fide redundancy?

Depending upon your Award or Enterprise agreement, a bona-fide redundancy can include the following payments:

• payment in lieu of notice
• severance payment of a number of weeks’ pay for each year of service
• a gratuity or ‘golden handshake’.

What is the tax treatment of a bona fide redundancy?

A genuine redundancy payment is made up of two components:

• A TAX FREE amount (Lump Sum D)
• An assessable amount (Taxed at marginal Rates

The Tax Free amount is capped every year to a maximum amount paid.

The concessional tax treatment for ETPs changed on the 1st July 2012.

Depending on the type of ETP, the concessional tax treatment is limited to the smaller of the ETP cap and the whole-of-income cap. Amounts paid in excess of these caps are taxed at the highest marginal rate (plus Medicare levy). You essentially need to work out the smallest cap. Ato guideline here.

ETP Cap rates are as follows:

General Tax         Years of Service       ETP            Whole of Income

Exemption              Exemption*       CAP**              Cap***

FY2020                  

FY2019            

FY2018                  $10,155                  $5,078               $200,000         $180,000

FY2017                 $9,936                     $4,969               $195,000         $180,000

FY2016                 $9,780                    $4,891                $195,000         $180,000

FY2015                $9,514                    $4,758                 $185,000         $180,000

* For Years of Service Exemption, the employee’s cap is calculated as General Tax Exemption + (Number of Full Year Service x Years of Service Exemption).

*** ETP Cap is the maximum tax free component of a an ETP for a genuine redundancy. There are other aspects to consider, but this is the most common.

*** The whole-of-income cap amount is not indexed. This cap is reduced by the other taxable payments that your employee receives in the income year. For example, salary or wages that you have paid to your employee. The Whole of Income Cap is relevant for Genuine Redundancies

Lump Sum E: Payments in arrears for prior income periods

The main use of this Lump Sum occurs when pay your employee a lump sum back payment for prior income years. Other uses include:

• salary or wages that accrued during a period of suspension and were paid to you on resuming duty
• back payments of non-superannuation annuities that accrued, in whole or in part, in an earlier year or years of income
• repatriation and social welfare pensions, allowances or payments, including those paid by foreign governments
• periodical workers and accident compensation payments but not payments made to the owner of the policy, and/or
• Commonwealth education or training payments.

As an employee, this allows you to apply for an income offset to restrict the amount of tax paid (especially if tax thresholds changed).

Please note this article is general advice. For specific advice tailored to your personal circumstances, you should consult your tax advisor.