If you have recently lost your job and are wondering how tax refunds on severance pay work and are considering claiming back taxes that may have been overpaid, you have come to the right place. A layoff is an emotional and financial challenge. Among the many adjustments, understanding your tax situation might feel like an unwelcome additional burden. However, at Taxfile we know that many people who are laid off are actually entitled to a tax refund or tax refund. That’s why we’re here to cut through the jargon and help you get back what you’re owed.
Why you may be entitled to a tax refund after a layoff
The PAYE puzzle
The British Pay-As-You-Earn (PAYE) system is designed to ensure a constant annual salary. If your employment ends in the middle of the tax year (which runs April 6–5), your employer likely deducted taxes based on the assumption that you would earn the entire year’s salary. This often results in an overpayment and possible tax refund after a layoff.
This is why this “PAYE conundrum” often leads to overpayment:
- Annual Tax Calculation: The Unfinished Year – Your income tax liability is calculated for the entire tax year. If your income stops or decreases significantly due to a layoff, your actual annual earnings will be lower than expected. This means you paid too much tax upfront on income that you ultimately didn’t earn throughout the year.
- Emergency Tax Laws: A Common Culprit — Sometimes a final payment or even the severance payment itself can be processed with an emergency tax code (like 0T M1). With these codes, tax is deducted at a higher, non-cumulative tax rate, which often results in a larger tax deduction than necessary. It is often HMRC’s “better safe than sorry” approach You are pay too much.
- Income below the personal allowance: The tax exemption limit – For the 2024/2025 tax year, most people have a personal allowance of £12,570 — this is the amount you can earn tax-free. If your total income for the year, including any taxable redundancy components, falls below this threshold, you will have unnecessarily paid tax on income that should be tax-free.
Understanding taxes on severance pay
Unpacking your package
This is often the most confusing part and is overlooked by many people. Not all money you receive when you leave your job is treated equally for tax purposes. Knowing the difference is key to calculating your potential refund.
- The £30,000 tax-free golden rule – The first £30,000 from you real compensation (employment compensation) is completely tax-free. This is a significant benefit designed to help individuals make this transition.
- What is taxable over £30,000? Any part of your redundancy payment that exceeds £30,000 will be subject to income tax at your marginal rate. This surplus is crucial not are subject to National Insurance Contributions (NICs), which is an important difference to regular income.
- Other payments that are ALWAYS taxable (beware of the “hidden taxpayers”) – Note that some payments are included in your severance package always taxable as ordinary income, regardless of the £30,000 threshold. This includes:
- Payment in lieu of notice (PILON) – Regardless of whether it is contractual or non-contractual, money paid in lieu of honoring your notice period is subject to income tax and national insurance.
- Accrued vacation pay – Payments for unused annual leave.
- Outstanding wages, bonuses or commissions – Any wages for work you have already done or earned.
- Restrictive agreements – Payments for consent not for example, working for a competitor.
| Insight into the control file: It’s important not to just assume that your employer has calculated everything correctly. Overpayments or underpayments may occur, and it is ultimately your responsibility to ensure you pay (and reclaim) the correct amount of tax. We have seen many cases where a simple review of the discharge settlement reveals significant overpayments. |
How to claim your tax refund
Your options (and how Taxfile can help)
The manner in which you claim tax back following a layoff will largely depend on your individual circumstances. Here are the common routes:
- The all-important P45 – Your employer must Provide you with a P45 upon your departure. This important document summarizes your payroll and tax deductions for the current tax year. Keep all parts safe — for most needs you will need parts 2 and 3!
- If you remain unemployed (for more than four weeks) and do not claim taxable benefits:
- You can often get a refund within the year by filling out an Form P50 (“Tax refund if you stop working”). You send this to HMRC along with parts 2 and 3 of your P45.
- Alternatively, you can request your refund online via your HMRC Personal Tax Account – This is often the quickest and easiest way if you are comfortable with online services.
- If you are starting a new job quickly (within 4 weeks):
- Pass parts 2 and 3 of your P45 on to your new employer. Your tax law should then be adjusted and the overpaid taxes should be refunded via PAYE with your new salary. It may take a few payment cycles for the adjustment to become visible.
- If you claim taxable benefits:
- If you claim benefits such as Jobseeker’s Allowance or Carer’s Allowance (which are taxable), Social Security will usually manage your tax refund as your benefits affect your overall tax situation. You will need to send them parts 2 and 3 of your P45. (Note: Universal Credit is generally not taxable, so you can still claim directly to HMRC if this is your only benefit.)
- HMRC P800 tax calculation (the automatic check):
- After the end of the tax year (which is April 5th, so normally summer 2025 for the current tax year) HMRC will review the PAYE records. If an overpayment is detected, they will send you a tax calculation of P800 explaining how to claim your tax refund. Important: Since May 2024, HMRC often requires you to actively claim your P800 refund online, rather than sending it automatically. Don’t miss this!
- Tax return for self-assessment (for complex cases):
- If your tax affairs are more complex (for example if you are self-employed, have significant other income or need to declare certain payments that fall outside standard PAYE), you may need to file, or choose to file, a self-assessment tax return. Overpaid taxes would then be reclaimed via this comprehensive procedure.
| Important deadlines: Don’t delay! You can usually claim a tax refund up to an amount of up to 10% four tax years after the end of the tax year in which you paid too much. For example, for the tax year ending April 5, 2021, the deadline for claiming would have been April 5, 2025. Don’t leave money on the table! |
Beyond reimbursement: What else should you consider after discharge?
Although getting your tax refund is important, being laid off can involve other financial considerations:
- Pension contributions – If you received a significant severance payment, consider whether some of it could be paid into your pension. This can lead to significant tax savings and increase your retirement savings.
- New labor and tax laws – Make sure your new employer is using the correct tax code from your P45. If you don’t have one, you may initially be assigned an emergency code, which could result in overpayments.
- Become self-employed? A layoff often triggers the step into self-employment. If this is your plan, you will need to register with HMRC as a sole trader and understand your new tax obligations (e.g. self-assessment, Class 2 and Class 4 NICs). Taxfile specializes in supporting the self-employed!
- Income protection/benefits – Check your income protection insurance or see if you are eligible for government benefits to cover the gap.
- Financial planning – This is an opportune time to review your overall financial situation, budget, and future goals.
Let Taxfile take the burden off your shoulders
Dealing with tax refunds after a layoff can be complex, especially during an already stressful time. At Taxfile we have extensive experience in helping individuals like you reclaim the taxes they owe quickly and efficiently.
Why choose Taxfile?
- Expert advice – We understand the nuances of severance pay and tax laws.
- Stress-free process – We can handle the paperwork and communications with HMRC on your behalf.
- Maximize your refund — We make sure you make all the claims you are entitled to, avoiding common pitfalls.
- Personal advice – Beyond reimbursement, we can advise you on your next financial steps, whether it’s understanding the taxes on a new job or becoming self-employed.
Don’t allow overpaid tax to remain with HMRC. Contact Taxfile today for a non-binding discussion about your severance tax refund. We will help you get your money back and no longer have to worry.
