Upon termination of employment, an employer pays an employee an employment termination payment (ETP). An employee's termination payment is usually paid as a lump sum as part of their final pay check.

Upon resignation or termination, eligible termination payments are taxed differently than an employee's salary or other components of their final pay.

Employers need to understand the following:

• What is an Employee Termination Payment?
• When is an Employee Termination Payment applicable?
• What’s included in an Employee Termination Payment?
• What’s not included in an Employee Termination Payment?
• How is ETP calculated?
• Factors to consider for Employee Termination Payments
• Employee Termination Payments - Payment and reporting

What is an Employee Termination Payment?

An employment termination payment (ETP) is a lump sum payment received following termination of employment.

Upon termination of employment, employees are entitled to receive a lump sum or several lump sums as their final pay. When calculating final pay, an employer must decide whether any part of the final pay is an ETP. Tax rates on certain payments are lower than on regular payments, and only certain payments are eligible for tax breaks.

When is an Employee Termination Payment applicable?

The employer's obligations to an employee do not end when the employee's contract terminates. Employee termination payments (ETPs) are usually required even if the employee leaves voluntarily, underperforms, or does not fulfil their employment duties.

Employees who terminate their employment are entitled to all monetary entitlements. Every worker will have a different amount, so understanding how to calculate it is essential.

An ETP can be classified as life benefit termination payments (life benefit ETPs) or death benefit termination payments (death benefit ETPs).

• In the event of termination of employment, a life benefit ETP is paid to the employee.
• In the event of the death of an employee, an ETP is paid as a death benefit.

What's included in an Employee Termination Payment: 

• Payment for any unused sick days
• Payment for rostered days off.
• Payment in lieu of notice instead of working the notice period.
• Severance or gratuity payment is also known as a 'golden handshake'.
• Redundancy or early retirement payments that exceed the tax-free element of the scheme.
• Payments due to an employee's invalidity (other than compensation for personal injury).
• Death benefits paid to another person after the death of an employee.

What's not included in Employee Termination Payment:

• Salary, wages, or allowances that an employee is entitled to, regardless of ETP
• Superannuation benefits
• Payments for unused annual leave
• Payment for unused long service leave
• Payments made under a genuine redundancy or early retirement scheme are tax-free.
• Deemed dividends.
• Compensation payments for personal injury.
• Restraint of trade payment when an employee agrees not to compete with the employer after termination.

Payments considered ETPs must be paid within 12 months after termination unless they are genuine redundancy or early retirement scheme payments (other exceptions may apply).

How are Employee Termination payments calculated?

Several factors impact Employee Termination Payments. Knowing all the elements of an employer's legal obligations is essential.

Six factors to consider for Employee Termination Payments

1. Who terminated the employment?

Employment can be terminated at the employer's request or the employee's request or by mutual agreement.

Death benefit terminations are taxed differently from life benefit terminations, but an employee's death can be considered a termination.

2. Taxation rules for Employee Termination Payments

Some payments are considered part of an Employment Termination Payment and have special tax treatment - these include:

• Unused annual leave
• Unused sick leave
• Golden handshakes or gratuities

To qualify for special taxation treatment, the Employee Termination Payment must be paid within 12 months of the termination.

3. Are there any in-lieu-of-notice payments available to the employee?

According to the Fair Work Act, employers must provide employees with a specific period of notice of termination or pay the equivalent amount in lieu of notice.

If the employee worked until the end of the minimum notice period, the amount in lieu is calculated at their full pay rate. In addition to receiving a payment in lieu of notice, an employee may also work out the notice period.

4. Is the employee owed payment for any accrued annual leave?

Annual leave that has yet to be used should be paid out unless the employee has used annual leave in advance.

Even when an employee has been terminated due to serious misconduct, accrued annual leave must always be paid out. Accrued annual leave is paid out regardless of who initiated the termination.

5. Is the employee entitled to any other payments?

Upon termination, employees must receive full payment for all work performed. Additionally, the employee may be entitled to the following payments:

• Overtime payments
• Personal leave, including carers leave.
• Public holidays
• Annual leave pro rata payments
• Long-service leave

A commission arrangement may also require employees to receive commissions or bonuses earned before termination (but not verified at the time of termination).

6. Is the employee entitled to severance or redundancy pay?

Severance pay may be available to eligible employees based on their years of continuous service and age. Employee compensation is outlined in the National Employment Standards (NES). The pay for a year of continuous service would be four weeks, and the payment for ten years would be 12 weeks.

Fair Work Australia may reduce an employer's redundancy pay if the employer finds another acceptable job for the terminated employee or the employer cannot pay the legally prescribed amount. On the Fair Work website, you can find more information on redundancy pay & entitlements.

Employee Termination Payments - Payment and reporting

Employee Termination Payment: When should it be paid?

Employees must receive termination payments within 12 months of their termination. A genuine redundancy payment, however, does not fall under the 12-month rule.

Employment Payment Summary: What is it?

After terminating an employee's employment and paying an ETP, an employer must issue a separate PAYG Payment Summary - employment termination payment.

Employees must receive this ETP Payment Summary within 14 days of the employer's payment, including the ETP amount and any associated withholdings. The employee will use this code at the end of the year to file their income tax return.

ETP payment summaries should clearly state the following:

An employee's taxable ETP component

• Withheld tax amount
• Each ETP code type
• Each ETP requires a separate payment summary

Employers must provide an ETP payment summary to the employee within 14 days of receiving payment. An ETP payment summary form is available on the ATO website.

Tax reporting for ETP

An employer must submit the employee's PAYG Statement and the original ETP Summary to the ATO. ETP payment summaries can either be lodged online or mailed to the ATP. The ATO will not accept payment summaries generated by payroll software. In addition, employers must keep a copy of the payer copy for five years.

Useful Terms

Dismissal with notice: When an employee's employment is terminated, and they have a set notice period, usually following an award or enterprise agreement, legislation, or employment contract.

A payment in lieu of notice: Offered by employers who, instead of giving their employees notice, pay them the wages they would have received if they had continued to work. Only industrial instruments, legislation, or employment contracts permit payment in lieu of notice.

Summary dismissal: When an employee's employment is terminated for serious misconduct. Summary dismissal is an immediate dismissal without notice provided by the employer. Generally, summary dismissal is only in cases of serious misconduct.

Unfair dismissal: Dismissed or fired employees can apply unfair dismissal to the Fair Work Commission seeking reinstatement or compensation if they believe their dismissal or termination was unfair, harsh, or unreasonable.

General protections: If an employee feels adverse action has been taken against them following the termination of their employment, they can seek several different remedies from the Fair Work Commission.