If you are a full-time employee, and you receive a lump sum payment from your employer in compensation for:
- a reduction in future pay,
- a change in working conditions,
- a change of working location,
then you can recompute your income tax liability for the tax year in which the payment is charged, as:
- the tax that you would have paid had you not received the payment, plus
- the tax on the payment calculated using a special rate.
The special rate to be applied to the payment is computed by working out the additional tax that results from including only one-third of the payment in your total income. The additional tax is then divided by one-third of the payment to obtain the percentage rate to be used in calculating the tax on the payment.
Mr X is a single person entitled to the basic personal tax credit and PAYE tax credit only. His salary for 2022 is €34,000. He also receives a sum of €6,000 in 2022 in consequence of his employer reorganising his business.
Step 1: Calculate tax on income including lump sum
€34,000 at 20% = €6,800 plus €6,000 at 40% = €2,400
Total €9,200, less €3,400 personal tax credits = €5,800
Step 2: Calculate tax on income without lump sum
€34,000 at 20% = €6,800 less €3,400 personal tax credits = €3,400.
Step 3: Calculate tax on income including only 1/3 of lump sum
€36,000 at 20% = €7,200, less €3,400 personal tax credits, is €3,800.
Step 3 minus Step 2:
The additional tax due by including 1/3rd of the lump sum is €400 (i.e. €3,800 – €3,400).
The special rate is (400/2000) x 100 = 20%.
Mr X’s tax for the year is recalculated as:
Tax on lump sum €6,000 at 20% = €1,200
Tax on income excluding lump sum = €3,400 [Step 2]
Total tax due = €4,600
Mr X is entitled to reclaim €1,200 (i.e. €5,800 – €4,600).
In practical terms, the tax on the lump sum is reduced from €2,400 to €1,200.
Further reading: TCA 1997 s 480