UK Settlement Agreements and the US Person: Why the Tax-Free £30,000 Is Not Tax-Free

A UK settlement agreement is almost always priced in UK tax. If you are a US citizen or green card holder, the slice that arrives UK-tax-free can still be fully taxable in the United States — and because no UK tax was paid on it, there is nothing to credit against the US charge. The net figure you agreed across the table is therefore not the net figure you keep.

Key takeaways

• The UK splits a package into elements: contractual pay, accrued holiday and bonuses are taxed as normal earnings, and post-employment notice pay is carved out and taxed in full.
• Section 403 ITEPA 2003 exempts the remaining termination award only to the extent that it exceeds £30,000, and HMRC is explicit that this threshold does not apply to post-employment notice pay.
• The US taxes its citizens on worldwide income, requires severance to be included in income, and has no equivalent exemption — so the UK-exempt slice carries no UK tax to credit against the US charge. That is where the arithmetic breaks.
• Source follows where the services were performed, not where the money is paid. For an employment spanning both countries, that allocation decides whether a credit exists at all.
• Severance can sometimes be foreign earned income, but the IRS excludes payments received after the end of the tax year following the year the services were performed.
• The UK tax year runs 6 April to 5 April and the US year is the calendar year, so one payment can land in different periods on each side.
• Model the after-US-tax number before signing, and keep the workday evidence behind your allocation.

This article is about tax. It is not employment-law advice: the terms of the agreement itself — the waiver, the reference, the covenants, the independent-adviser requirement — should be reviewed by an employment solicitor.

How the UK breaks a package apart

There is no single "termination payment" in UK tax. HMRC disassembles the package and taxes each piece on its own footing.

Contractual pay for work already done is simply earnings: unpaid salary, accrued but untaken holiday, and bonuses. GOV.UK's redundancy guidance lists exactly these among what a termination payment may include — statutory redundancy pay, holiday pay, unpaid wages, company benefits, for example bonuses — and they run through payroll in the ordinary way.

Then comes the part that catches people out. Employers must carve out post-employment notice pay (PENP): the value of the notice period that will not now be worked. HMRC's manual is blunt that this must be done whether or not the employee, or former employee receives a contractual, or non-contractual PILON. Notice pay cannot be relabelled as compensation.

PENP is computed by a statutory formula in section 402D ITEPA 2003, which HMRC sets out as ((BP × D) ÷ P) − T — BP being basic pay for the last pay period ending before the trigger date, D the calendar days in the post-employment notice period, P the calendar days in the last pay period, and T broadly any termination payment already chargeable outside the termination-payment rules. The result cannot be negative, and is capped at the total relevant termination awards.

Whatever survives that exercise — genuine compensation for loss of office, an ex gratia sum, statutory or enhanced redundancy pay — is the element the exemption can reach.

The exemption, and what it does not touch

Section 403(1) ITEPA 2003 provides that qualifying payments and benefits count as employment income only to the extent that they exceed £30,000. GOV.UK puts the consumer version plainly: statutory redundancy pay under £30,000 is not taxable. Two limits matter far more than the number itself.

• The threshold does not apply to PENP. HMRC states this directly. Notice pay is taxable from the first pound, however the agreement labels it.
• It does not apply to contractual entitlements. Holiday pay and bonuses are earnings, not termination awards, and never enter the £30,000 calculation.

There is also a foreign-service dimension that internationally mobile employees are often told about second-hand, and incorrectly. A reduction for foreign service exists, but HMRC confirms it is no longer available for section 401(1)(a) payments where the employee is UK resident for the tax year the employment terminates, the employment terminated on or after 6 April 2018, and the payment was received after 13 September 2017 — subject to a narrow carve-out for foreign seafaring service.

From 6 April 2026 there is a further layer. Section 38A ITEPA 2003 addresses earnings relating to duties not performed, and HMRC states that an individual can choose whether to apply section 38A ITEPA 2003 or section 414 ITEPA 2003 — not both. For PENP, section 38A looks at the duties it is reasonable to assume would have been performed during the notice period had the employment continued. Which route gives the better answer is a computation, not a preference, and it is worth running before signature rather than after.

Restrictive covenants and confidentiality

Settlement agreements routinely pay for silence and for a period out of the market. The UK answer is unambiguous: under sections 225 and 226 ITEPA 2003, receipts for restrictive covenants are treated as earnings from the employment.

That is a full charge, with PAYE applied. Where a package is loosely drafted and a meaningful sum sits against confidentiality or a non-compete, the exemption everyone assumed would shelter it simply does not reach.

Employer National Insurance on the excess

The employer, not the employee, picks up a Class 1A National Insurance charge on the termination award above £30,000 where Class 1 has not already applied. HMRC's CWG5 guidance confirms there is no employee contribution payable, and that the liability must be reported in real time, on or before the award is paid, rather than through the annual P11D(b) process. Rates are set each year and published on GOV.UK.

This matters to the negotiation even though it is not your tax: it is a real cost to the employer on every pound above the threshold.

The US side: no mirror exemption

Here the model collapses. A US citizen is subject to tax on worldwide income from all sources, wherever they live. On severance specifically, IRS Publication 525 states that you must include in income amounts you receive as severance pay and any payment for the cancellation of your employment contract.

Read those alongside the UK outcome. The award has been exempted in the UK up to the threshold; the US taxes it anyway; and because no UK tax was paid on that slice, there is no foreign tax to credit against the US liability on it. The UK relief has not saved money — it has moved the tax across the Atlantic, at US rates, payable personally.

Accrued holiday and restrictive-covenant payments are taxable on both sides. It is specifically the UK-exempt portion that is exposed, which is precisely the portion a UK-only model treats as the most valuable part of the deal.

Sourcing decides whether a credit exists

For a senior executive whose role spanned London and the US, the next question is where the payment comes from — and the rule is about services, not bank accounts. The IRS is explicit that the source of your earned income is the place where you perform the services for which you receive the income, and that where or how you are paid has no effect on the source of the income. Where services are performed in more than one country, the IRS applies a time basis, multiplying the total amount of pay by the fraction of days in which services were performed in the relevant country over total workdays.

Severance is compensation for services, so it inherits that logic. The difficulty is identifying the service period the payment relates to: notice pay looks forward to a period that will never be worked, while an ex gratia sum may reflect a whole career. Two people with identical contracts can land on different allocations, which is why this is argued from evidence rather than assumed.

Sourcing is not academic, because the credit is limited. IRS Topic 856 confirms the credit is the smaller of the amount of foreign tax paid or accrued, or the amount of U.S. tax attributable to your foreign source income, computed separately by category, with unused credit carried back one year and forward ten. Compensation treated as US-source generates no credit capacity at all, even where the UK has taxed it — a mismatch that pushes excess UK tax into the carryover pool, covered in foreign tax credit carryovers.

Nor does the treaty rescue a US citizen. Article 1(4) of the 2001 UK-USA convention allows a Contracting State, by reason of citizenship, to tax its citizens as if the convention had not come into effect. Relief runs through the credit, not the employment article.

Can severance be foreign earned income?

Sometimes — and it is worth testing, because the exclusion applies to income for services performed in a foreign country, and a termination payment may relate to exactly such services. But two conditions bite hard. You must still qualify for the year under the bona fide residence or physical presence test, which is frequently the problem: people leave the UK when the job ends, and the year of departure is the year the money arrives. And the IRS excludes payments received after the end of the tax year following the tax year in which you performed the services that earned the income.

So a deferred instalment, or a payment made well after a departure, can fall outside the exclusion even where the underlying services were unambiguously foreign. The answer turns on the facts and on the period the payment relates to, so it should be tested, not assumed. Where the departure and the payment land in the same year, the interaction with your residence position is set out in the moving year.

Two tax years, one payment

The UK tax year runs from 6 April to 5 April; the US year is the calendar year. A payment agreed in March and made in April sits in different periods on each side, and UK PAYE deducted in one UK year may need to be matched against a US liability arising in a different calendar year. Three exposures follow.

• US tax can fall due in a year with little or no UK tax available to credit against it, even though both charges arise from the same package.
• Instalments split across tax years can separate the income from the tax paid on it, worsening the limitation in one year while wasting capacity in another.
• Unvested equity is often accelerated or bought out in a settlement, carrying its own sourcing and timing rules — see equity compensation and US tax.

Model it before you sign, and keep the evidence

The agreement is where the leverage sits. Once signed, the allocation between elements is fixed and the tax follows it. Before signature, we would want to see the split between notice pay, accrued holiday, other contractual sums, restrictive covenants and the compensatory element; the PENP calculation the employer has run; the workday history behind any UK/US allocation; the payment dates and whether they straddle tax years; and the treatment of any equity or continuing benefits.

Then keep the evidence. Calendars, travel records, assignment letters and payslips are what support a sourcing position years later, when the US return is prepared and the allocation has to be justified. Assemble it as you leave, while you still have access to it.

How we work on these

We model the package on both sides before signature and give you one after-tax number, then prepare the UK and US positions consistently so the two returns tell the same story. A licensed CPA or Enrolled Agent reviews and signs off every US filing; the UK side is reviewed by an ACCA-qualified accountant. Our US-UK expat tax service is built for exactly this. If an agreement is on the table, book a confidential consultation before the numbers harden.

This article is general information, not tax or legal advice, and does not create a professional relationship. It does not address employment law; take independent legal advice on the agreement itself. Termination payments are highly fact-dependent and the rules change, so figures, thresholds and reliefs should be confirmed against current official guidance before you act.

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Reviewed by a CPA / Enrolled Agent. Last updated: 20 September 2026.

Official sources: HMRC EIM13505 | HMRC EIM13700 | HMRC EIM13874 | HMRC EIM13879 | HMRC EIM13880 | HMRC EIM03600 | GOV.UK redundancy: tax and National Insurance | GOV.UK CWG5 (2026) | 2001 UK-USA Convention | IRS Pub 525 | IRS US citizens and resident aliens abroad | IRS foreign earned income | IRS source of income: personal service income | IRS Topic 856