Dominic Coyle answers your financial queries.

Tax implications of redundancy

My company is currently offering a redundancy programme and I am trying to figure out whether it is worth my while taking up the offer. Can you tell me how redundancy payments are taxed? Someone told me they were tax free but I have also heard elsewhere that this is not the case.

The company is not going out of business so this is not a compulsory redundancy situation. I have worked with this employer for 21 years.

Mr D.M., Dublin

Whether these redundancies are voluntary or compulsory does not ultimately affect the tax treatment of the payment you will receive. What is important is the nature of the payment.

The reason you have heard conflicting views about the tax liability on redundancy payments is that some elements are tax free while others are not.

All redundancy situations involve payment of statutory redundancy. Most, especially in the case of voluntary redundancies such as yours, also involve additional payments over the statutory minimum.

In tax terms, statutory payments are tax free - as are any payments in lieu of notice - while additional redundancy lump sums are liable for tax, depending on the amount.

You don't say what your earnings are or the details of your company's offer, so I will simply run through an illustrative example based on your years of service. You will be able to apply the rules to your own particular situation.

Let's assume your employer is offering six weeks' pay per year of service in this redundancy programme, including statutory redundancy.

First, in relation, to statutory redundancy, the rules state that you are entitled to two weeks pay per year of service and one additional week. In your case this would amount to 43 weeks' pay - two for each of your 21 years' service and the extra one at the end.

There is, however, a catch. Regardless of what you actually earn, the State has set a ceiling for statutory redundancy payments - €600 a week. If you earn less than this in gross pay, you work out your entitlement on the basis of your earnings.

Let's assume you earn an annual salary of €50,000 - equating to €961.54 gross a week. In your case, you will multiply the maximum weekly allowance of €600 by the 43 to give you a statutory lump sum of €25,800. This money is not taxed and will be paid to you directly by your employer.

Things get more complicated thereafter. On the basis of an offer of six weeks' pay per year of service, a salary of €50,000 and 21 years' service, the total redundancy lump sum would be €121,154.04.

Leaving aside the €25,800 statutory redundancy, the remaining €95,354.04 amounts to non-statutory redundancy and is potentially taxable.

Assuming this is your first redundancy, you are entitled to the higher of:

basic exemption;

increased exemption;

standard capital superannuation benefit.

The fact that a spouse may have previously availed of a redundancy payment does not affect your position.

The basic exemption amounts to €10,160 plus €765 for each full year of service. In your case, assuming the 21 years are full years of service, this would amount to €26,225: (€765 x 21) + €10,160.

Under the increased exemption scheme, people who are not members of an occupational pension scheme or who given up their right to a lump sum from such a pension scheme, the basic exemption is increased by €10,000, raising the figure in your case to €36,225.

If you have taken or intend to take a pension lump sum of less than €10,000 (say €7,000), the balance (in this case €3,000) can be added to the basic exemption.

The third option - standard capital superannuation benefit - generally proves the best option for people with long service and/or high earnings.

This works on a formula. First you take your salary for the three years prior to redundancy and divide the figure by three to give an average annual earnings figure.

In the illustrative case, you earn €50,000. For argument, let's say this has risen from €48,000 a year ago and €46,000 in the previous year. These three would tot up to €144,000 which, divided by three, amounts to €48,000.

You multiply this by the number of years served and divide by 15. In our illustration this works out as €67,200: €144,000 / 3 = €48,000 x 21 / 15.

From this figure, you deduct any lump sum received or due from an occupational pension scheme.

In your case, unless, you are taking a sizeable pension lump sum, it appears as though this might be the best option for you. From your €121,154.04 redundancy lump sum, assuming you take no lump sum from your pension, your tax-free sum would be €93,000 (€25,800 statutory redundancy and €67,200 under the standard capital superannuation benefit formula).

The balance, in this case €28,154.04, is taxable in the year it is received. In general, it will be at your higher or marginal rate. However, Top Slicing Relief is available. This ensures that you don't pay tax at a rate higher than your average rate of tax in the three years prior to the redundancy.

You will not be liable to PRSI on this sum but you will have to pay the health levy.

Please send your queries to Dominic Coyle, Q&A, The Irish Times, D'Olier Street, Dublin 2 or e-mail to dcoyle@irish-times.ie. This column is a reader service and is not intended to replace professional advice. Due to the volume of mail, there may be a delay in answering queries. All suitable queries will be answered through the columns of the newspaper. No personal correspondence will be entered into.