Employment Termination Payment Tax Guide Australia (2026)

A staff member is leaving. The relationship might have ended well, badly, or somewhere in the middle. Either way, the tax treatment of the final payment matters straight away.

For many Sydney business owners, confusion starts here. You search “severance pay tax”, find pages talking about US federal withholding, and end up with advice that does not match Australian law at all. That is a problem, because employment termination payment tax in Australia follows its own rules, its own categories, and its own deadlines.

If you run a business in Ashfield, Belrose, the Inner West or the Northern Beaches, this is not just an HR issue. It is a payroll, compliance and cash flow issue. Get the classification wrong and you can under-withhold, over-withhold, misreport to the ATO, or give a former employee the wrong expectations about what lands in their bank account.

Introduction Why ETP Tax Rules Matter for Sydney Businesses

A small business owner in Ashfield makes a long-serving employee redundant. A builder on the Northern Beaches agrees a retirement package with a senior foreman. An office manager in the Inner West finishes up after a restructure. The amounts involved can look similar on paper, but the tax result can be very different.

That is why employment termination payment tax Australia searches often lead people astray. Much of what appears online is written for the US. Australian law is different. One of the biggest differences is that a genuine redundancy payment in Australia can include a tax-free component, which is not how the common US-style severance explanations work. A broad comparison is outlined in this summary from Multiplier on severance pay taxation.

Why the distinction matters in practice

When a staff member leaves, their final payment is rarely one lump with one tax treatment.

You might be dealing with:

• wages up to the finish date
• unused annual leave
• long service leave
• payment in lieu of notice
• a redundancy payment
• an ex gratia amount
• a settlement component

Each piece can sit under different rules. If you treat the whole lot as ordinary wages, that can be wrong. If you treat the whole lot as an ETP, that can also be wrong.

Practical tip: Think of termination pay as a ute tray with separate tubs. If you throw every part into one tub, the ATO treatment usually goes wrong.

Why business owners need the right Australian guide

The issue is not only tax withheld today. It is also reporting, payroll coding, and whether the employee later gets an unpleasant tax surprise.

For employers, the best approach is to classify each component before money goes out. For employees, it helps to understand why one part of a payout is taxed differently from another.

If you want a plain-English Australian overview before dealing with the detail, A Guide to Employment Termination Payment Tax in Australia is a useful starting point.

What Exactly Qualifies as an Employment Termination Payment

The cleanest way to understand an ETP is to split a final payout into buckets.

One bucket holds ordinary amounts connected to employment, such as salary for work already done. Another bucket holds leave entitlements that have their own tax rules. Then there is the ETP bucket, which is for eligible payments made because the employment has ended.

What usually sits in the ETP bucket

An employment termination payment can include amounts like these:

• Payment in lieu of notice if it is part of the termination arrangement
• Ex gratia payments made on termination
• Compensation for loss of employment, such as certain settlement amounts
• Unused sick leave paid out where that entitlement is paid on termination
• Taxable parts of genuine redundancy or early retirement scheme payments once the tax-free component is excluded

These are the kinds of amounts that are connected to the ending of the job itself, not to hours worked or leave accrued in the usual way.

What does not go in the ETP bucket

Some amounts are commonly confused with ETPs, but they are treated separately:

• Salary and wages for work performed up to the last day
• Unused annual leave
• Unused long service leave
• The tax-free part of a genuine redundancy payment
• Superannuation rollovers
• Employee share scheme benefits

This distinction matters because the tax rates, withholding method and reporting can differ.

A practical way to review a final payment

When I review a termination package, I usually start with three questions:

1. Was this amount earned by doing work?
   If yes, it often belongs with salary and wages.

2. Is this a leave entitlement?
   If yes, it often follows its own leave rules rather than ETP rules.

3. Was this amount paid because the employment ended?
   If yes, it may fall into the ETP category.

That sequence catches many errors early.

Key takeaway: The label in the deed or payroll file does not decide the tax outcome on its own. The legal character of the payment matters more than the nickname people use for it.

Why payroll coding often goes wrong

The usual trouble spots are settlement deeds, redundancy letters, and manually prepared final pays. A bookkeeper or payroll officer can receive one total figure and assume it all goes through the same way. That is where mistakes happen.

If you need a broader explanation of the categories, this page on understanding eligible termination payments helps frame the core distinction between ETP and non-ETP amounts.

Genuine Redundancy Payments vs Other ETPs

A builder in the Northern Beaches shuts down a small joinery arm after two slow quarters. One carpenter is let go because that part of the business is gone. In Ashfield, a cafe owner parts ways with a supervisor after repeated management issues, but hires someone else into the same job a week later. Both employees receive a final payout. The tax result can be completely different.

For a payment to qualify as a genuine redundancy, the employee must lose their job because the role is no longer needed. The focus is on the position, not the person. That is the point many Sydney small business owners miss, especially after reading US articles on severance that do not match ATO rules.

What a genuine redundancy looks like

A genuine redundancy usually arises after a real business change, such as:

• a plumbing business in the Inner West closes its maintenance division
• a Northern Beaches workshop removes an admin role after moving to outsourced bookkeeping
• a retailer merges two store manager roles into one after a restructure
• new systems remove the need for a scheduling position

The common thread is simple. The job has gone.

If the business still needs someone doing substantially the same work, the payment is much harder to support as a genuine redundancy, even if the letter says "redundancy".

What usually falls outside genuine redundancy

These are the cases I see mislabelled most often:

• performance exits described as redundancies to soften the message
• conduct dismissals
• negotiated separations where the role continues
• retirement arrangements that do not meet the tax rules
• ex gratia or "golden handshake" amounts paid to encourage someone to leave

The paperwork matters, but the facts matter more. If the role survives and another employee steps into it with minor title changes, the ATO is likely to look past the label.

The tax-free part of a genuine redundancy

A genuine redundancy can include a tax-free component. That is the main reason the distinction matters.

For the 2025-26 income year, the tax-free limit is made up of a base amount plus an amount for each completed year of service, using the figures published by the ATO on genuine redundancy and early retirement scheme payments.

For employers, the practical point is straightforward. Part of the payment may sit outside the taxable ETP rules if the redundancy is genuine. A standard ex gratia termination payment does not get that same treatment.

Quick comparison

A local example

Say a Belrose electrical contractor loses a commercial maintenance contract and no longer needs one estimator role. The business removes that position from the org chart and spreads the remaining quoting work across the owner and leading hand. That can support a genuine redundancy outcome if the records line up.

Now change one fact. The contractor lets the estimator go, then advertises for a "project pricing coordinator" with nearly the same duties. That starts to look like person removal, not role removal. The tax treatment can shift with it.

Common mistakes Sydney employers make

Three problems come up again and again in small business payroll files:

• Treating a dispute exit as a redundancy
  A settlement deed does not turn a conduct or performance matter into a genuine redundancy.

• Using rough service dates
  The tax-free formula uses completed years of service. Payroll needs the exact start and end dates.

• Documenting the payment, but not the business decision
  Redundancy letters help, but they should be backed by board notes, management records, contract losses, restructure plans, or other evidence showing why the role disappeared.

For tradies, the easiest way to test it is this. If the ute still needs a driver next Monday, it probably is not a redundancy. If the work itself has dried up and the seat is gone for good, you may be in genuine redundancy territory.

The ETP Caps and Tax Rates for 2026

A payout can look generous on paper and still create a tax mess if payroll applies the wrong cap or rate.

For Sydney small business owners, online advice often goes off track at this point. A lot of what turns up in search results is US content about severance, not Australian ETP rules. For an Ashfield café group, a Belrose plumbing business, or an Inner West agency, the result is the same. Payroll needs the Australian cap for the correct income year, the employee’s age, and the right payment classification before the money goes out.

The concessional rates

If the payment qualifies for concessional ETP treatment, the taxable amount up to the relevant cap is generally taxed at:

These rates are inclusive of the Medicare levy.

The cap that matters

The cap is not a side issue. It decides how much of the taxable ETP gets concessional treatment and how much does not.

For practical payroll work, use the cap that applies in the income year the employment ends and the payment is made. Do not pull last year’s spreadsheet from the server and hope the settings still work. That is how small errors turn into amended payroll reporting, employee complaints, and avoidable ATO attention.

This matters more than many owners expect. A Northern Beaches builder paying out a long serving site manager can move past the concessional threshold faster than planned, especially if the package was negotiated quickly to get the separation finalised.

Why age changes the withholding result

Preservation age affects the concessional tax rate on the amount within the cap.

So two employees leaving the same business with similar taxable ETP amounts can have different withholding outcomes. The payroll result changes because their ages differ, not because one payment was calculated incorrectly.

What happens above the cap

Amounts above the relevant cap do not keep the same concessional treatment. They can end up taxed at marginal rates, potentially reaching high marginal rates plus the Medicare levy depending on the timing.

That is usually the point where owners say the numbers feel harsher than expected. They are right.

A quick example helps. If an Inner West design business agrees to a larger exit payment for a senior employee to resolve the departure cleanly, the first part may receive concessional treatment, but the excess above the cap can be taxed much harder. The commercial deal may still be worth doing, but it should be costed properly before payroll processes it.

The point business owners should watch

Timing still matters, but the detailed 12 month rule is better dealt with alongside employer processing obligations.

The practical takeaway here is simple. Confirm the employee’s age, the current year cap, and the taxable ETP component before funds are released. Once the payment has been made and reported, fixing it is slower, more expensive, and harder to explain to the employee.

What works in practice

The employers who handle ETPs cleanly usually check three things before payment day:

1. they separate the taxable ETP from wages and leave payouts
2. they confirm the employee’s age against preservation age
3. they verify the correct cap and withholding treatment for that income year

That approach is boring. It is also what keeps a rushed termination from becoming a payroll cleanup job a month later.

Worked Examples Calculating ETP Tax in Practice

The easiest way to make employment termination payment tax Australia rules practical is to walk through real-style examples.

These are simplified examples. They show the method, not every possible payroll wrinkle.

Example one Maria from the Inner West

Maria is 45. She works as an office manager for a marketing agency in the Inner West. The business restructures and her role is abolished after 8 completed years of service.

Her termination package includes a genuine redundancy payment.

Step one. Work out the tax-free redundancy amount

Using the 2025-26 formula, the tax-free amount is:

• base amount $11,985
• plus $5,994 for each completed year of service
• Maria has 8 completed years

Calculation:

• $11,985 + ($5,994 × 8)

That gives Maria’s tax-free genuine redundancy component.

That tax-free component is carved out first. It is not treated the same way as the taxable ETP component.

Step two. Identify what remains

If Maria’s overall redundancy-related amount is more than the tax-free figure above, the excess can become the taxable ETP component, assuming it otherwise qualifies.

Any unpaid salary, annual leave, or long service leave still sits outside that ETP bucket and must be handled separately.

Step three. Apply the ETP rate

Maria is below preservation age. For the taxable ETP amount up to the cap, the concessional rate in the verified data is 32% including Medicare levy.

So the broad flow is:

• tax-free redundancy component first
• taxable ETP component next, taxed concessionally up to the cap
• non-ETP items taxed under their own rules

Employees often get confused at this point. They see one gross exit package and assume one tax rate applies to all of it. That is rarely how it works.

Example two Dave from the Northern Beaches

Dave is 61 and runs site supervision for a builder on the Northern Beaches. He agrees to retire and receives a golden handshake.

This is a useful contrast because a golden handshake is not the same as a genuine redundancy payment just because it is paid when employment ends.

Step one. Ask the right question

Was Dave’s role abolished?

If the answer is no, then he usually does not get the genuine redundancy tax-free formula discussed earlier.

Step two. Treat the amount as a taxable ETP

Assuming the payment qualifies as an ETP and is paid within the required timeframe, the concessional rate up to the cap depends on his age.

Dave is above preservation age, so the rate up to the cap is 17% including Medicare levy.

That lower rate is one of the most important practical differences for older employees receiving taxable ETPs.

Why this example matters

Many employers assume “retirement package” means “tax-free” or “lightly taxed”. It does not. The reason for the payment still matters.

A retirement payment can still be taxable as an ETP. It may attract a different concessional rate because of age.

Practical tip: If an employee is older, do not assume every termination amount gets the lower rate. First confirm that the amount is a taxable ETP and not some other category.

Example three Payment timing and the cap problem

Now take a larger termination amount for an employee whose taxable ETP is $100,000.

The verified data gives a direct timing comparison:

• if the payment is made on day 365, it can receive concessional treatment up to the applicable cap for 2024-25
• if the same payment is made on day 366, it becomes fully assessable income taxed at marginal rates under the timing rule described in the verified material

That is not a rounding issue. It is a completely different tax result caused by one missed deadline.

Why these examples matter for employers

From the employer side, worked examples highlight four practical habits:

• Break the package apart before processing
• Use completed years of service, not approximations
• Check whether the departure is a redundancy
• Do not let the payment drift past the timing deadline

Why these examples matter for employees

From the employee side, the big lesson is not to judge the tax result by the total payout figure alone.

A former employee might say, “I received this amount on termination, why was so much tax withheld?” The answer usually sits in one of these places:

• part of the package was never an ETP
• the payment was not a genuine redundancy
• the taxable amount exceeded concessional treatment limits
• the payment timing missed the rule

Employer Obligations and Common Pitfalls to Avoid

A builder in Belrose lets a supervisor go, agrees a payout, then leaves the paperwork sitting while cash flow is tight. A cafe owner in Ashfield does the same after a messy staff exit and assumes payroll can sort it out later. That is how ETP mistakes usually start. Not with a strange tax rule, but with a termination that was handled informally.

Sydney small businesses get caught here because the online advice is often written for the US or aimed at large HR teams. An Inner West retailer, a Northern Beaches electrician, or a local subcontracting business usually has one bookkeeper, one payroll system, and very little room for rework. If the payment is coded wrongly the first time, fixing it later can be expensive and awkward.

The employer’s job is straightforward in principle. Break the termination package into the right parts, withhold the right amount, report the ETP separately, and keep records that support the treatment if the ATO asks questions.

What employers need to get right

• Split the payment correctly
  Wages, unused leave, tax-free redundancy amounts and taxable ETP amounts do not belong in the same bucket.

• Apply PAYG withholding to the right component
  The withholding result depends on what the payment is, not what the settlement deed casually calls it. If your team needs a refresher, this guide on PAYG withholding meaning gives useful background.

• Report the ETP distinctly
  An ETP should not be blended into ordinary payroll figures and forgotten.

• Keep matching records
  The termination letter, final payslip, deed, payroll notes and termination date should all line up.

The deadline that causes the most damage

The 12 month payment rule catches more small employers than it should.

As noted earlier, concessional ETP treatment generally depends on the payment being made within 12 months of termination. Miss that timing and the employee can end up with a much worse tax result. In practice, I see this happen after settlement negotiations drag on, directors delay approval, or the business treats the payout like any other creditor.

For a Northern Beaches tradie business, the trap is often cash flow. Work is seasonal, a job debtor pays late, and the owner delays the termination payment by a few weeks without realising the tax character can change. For an Ashfield employer, the problem is often documentation. The staff member stops work on one date, the letter names another, and payroll uses a third.

Both situations are avoidable.

Common pitfalls I see in practice

Calling something a redundancy when the role still exists

A redundancy is about the job disappearing, not the employer wanting a clean exit. If the person leaves but the role is still there, the tax treatment can unravel quickly.

Using rough service periods

Completed years of service matter for redundancy calculations. "About seven years" is not a calculation.

Letting legal wording drive payroll coding

A deed might use broad commercial language to settle a dispute. Payroll still has to identify what each amount represents for tax purposes.

Leaving the termination date unclear

If the date is fuzzy across emails, letters and payroll records, timing issues become much harder to defend.

Practical tip: Lock in one termination date in writing, then make sure the lawyer, payroll officer and bookkeeper all use that same date.

Employment law and tax have to match

The tax treatment only works properly when the exit process itself is handled properly. If you are ending employment and want a plain English legal overview first, read how to fire an employee legally.

The practical risk is broader than a withholding error. You can give the employee the wrong net figure, lodge incorrect payroll reporting, or create an ATO problem that takes far longer to clean up than it would have taken to process the termination correctly the first time.

Tax Planning and When to Call Your Ashfield or Belrose Accountant

Not every ETP issue is fixable after the event. Some planning only works if it happens before the payment is made.

That does not mean there is endless flexibility. There is not. ETP tax law has hard rules. But timing, documentation, and classification can still be managed properly if someone checks the structure early.

Where planning helps

A few areas are worth looking at before the payment is processed:

• Timing across financial years
  This can affect the employee’s overall tax position, even where the ETP rules themselves are rigid.

• Correct characterisation of the payment
  A genuine redundancy, ex gratia amount, leave payout and wage payment do not belong in the same basket.

• Coordination with payroll and legal documents
  If the deed says one thing and the payroll summary says another, you are asking for trouble.

When DIY becomes risky

Business owners often try to solve ETP questions with online calculators, old payroll templates, or overseas articles. That usually works poorly.

The issue is not only getting the tax wrong. It is giving the employee the wrong net payment estimate, missing a reporting obligation, or creating an ATO review issue that takes time and money to fix later.

For local businesses wanting direct advice, especially around restructures, redundancies or negotiated exits, it makes sense to speak with a tax adviser who already works with Sydney small business conditions and payroll realities. If you are looking for a local accountant, this page for an accountant near me is a sensible place to start.

A simple rule of thumb

If the termination involves any of these, get advice before the payment goes out:

• a redundancy
• a deed of release or settlement
• a payment split across dates
• a large ex gratia amount
• uncertainty about whether the role is abolished

The cost of checking first is usually far lower than the cost of correcting it later.

Frequently Asked Questions on Employment Termination Payments

Can an ETP be rolled into super

Generally, no. An ETP is not something you roll over into super the way some people assume. This is a common misunderstanding because people hear “termination payment” and think all retirement-related money can be pushed into super. It cannot.

Are unused annual leave and long service leave part of the ETP

No. They are usually treated separately from the ETP bucket.

That is one of the biggest classification points in final pay processing. Leave entitlements often sit beside the ETP in the same termination pack, but they do not become ETPs just because they are paid on the same day.

What about death benefit ETPs

Death benefit ETPs are a separate category with their own rules and reporting issues. If payment is being made to a deceased employee’s estate or dependants, do not assume the normal employee rules apply unchanged. These matters need careful handling because the recipient and the payment character both matter.

Can legal fees for negotiating a termination package be claimed

Sometimes people assume all legal costs connected with ending employment are deductible. That is too simplistic.

The deductibility of legal fees depends on what the fees were for. If the fees relate to securing or negotiating amounts with a revenue character, there may be a different tax analysis than if the fees relate to capital matters or broader claims. This is an area where personalised advice matters because the deed terms and legal invoices need to be reviewed together.

What if part of the payment is delayed because negotiations drag on

That is where the timing issue becomes dangerous. If a payment that would otherwise be an ETP slips beyond the permitted timeframe, the tax treatment can change. Businesses should not let settlement discussions drift without keeping one eye on tax timing.

Do employees and employers both need advice

Often, yes.

The employer needs to get withholding, coding and reporting right. The employee needs to understand what is tax-free, what is concessionally taxed, and what is taxed another way. Those are related questions, but they are not identical.

If you need help working through an employment termination payment, tax withholding on a redundancy, or a final pay package that does not fit neatly into payroll software, speak with EndureGo Tax. We help individuals, tradies and small business owners across Ashfield, Belrose, the Inner West and Northern Beaches get the tax treatment right before a costly mistake is locked in.