Employee termination payments (ETPs) are among the most complex payroll events a bookkeeper handles. Unlike regular wages, ETPs involve multiple payment components that attract different tax treatments, different withholding rates, and specific caps that affect how much of the payment is taxed concessionally.
Getting the withholding wrong affects the departing employee's tax position. Getting the coding wrong distorts the employer's financial statements. Here's what bookkeepers need to understand.
Types of Payments on Termination
When an employee's employment ends, the payments made may include:
Unused annual leave. Paid out at the employee's ordinary time rate (or higher under an applicable award or agreement). For employees who commenced work before 18 August 1993, different tax rates may apply.
Unused long service leave. Tax treatment depends on when the leave accrued and the reason for termination. Pre-16 August 1978 accruals have concessional treatment; post-1978 accruals are generally taxed as ordinary income.
Payment in lieu of notice. If the employer pays the employee instead of requiring them to work out a notice period, this is taxable income included in gross wages — not an ETP.
Genuine redundancy payments. Payments made because a position is abolished (rather than because the employee is underperforming) attract a tax-free component based on years of service and the ATO's published genuine redundancy schedule.
Employment termination payments (ETP proper). These are payments made in consequence of the termination of employment that don't fall into the above categories — for example, compensation payments, contractual payments on early termination, and certain golden handshakes.
The ETP Distinction: Life Benefits vs Death Benefits
ETPs are classified as either life benefit ETPs (paid to a living employee) or death benefit ETPs (paid to the estate or dependants of a deceased employee). The tax treatment differs significantly.
For life benefit ETPs, the taxable component is taxed at a concessional rate (32% including Medicare levy for amounts up to the ETP cap; 47% above the cap). The ETP cap for 2025-26 is set annually by the ATO.
Genuine Redundancy: The Tax-Free Component
Genuine redundancy payments attract a tax-free component based on years of service. For 2025-26:
- Base tax-free amount: $12,524 (indexed annually)
- Per year of service component: $6,264 (indexed annually)
So an employee with 8 years of service who is genuinely made redundant has a tax-free threshold of $12,524 + (8 × $6,264) = $62,636. Any genuine redundancy payment up to this amount is tax-free. Amounts above it are ETPs.
Note: the genuine redundancy concession only applies if the redundancy is genuine — the position must be truly abolished, not just the employee terminated. If the employer fills the same role shortly afterward, the ATO may challenge the "genuine redundancy" characterisation.
Withholding on Termination Components
Different components of the termination package require different withholding treatment:
Unused annual leave paid out on termination:
- For employees with pre-18 August 1993 service: 32% flat rate on the pre-1993 component; marginal rate on the post-1993 component
- For all other employees: 32% flat rate
Unused long service leave paid out:
- Pre-16 August 1978 component: 5% flat rate
- Post-1978 component: 32% flat rate
Payment in lieu of notice: Withhold at the employee's marginal rate (same as ordinary wages).
ETP (life benefit):
- Taxable component up to the ETP cap: 32% (under age 60 preservaton age — higher rates apply in different circumstances)
- Taxable component above the ETP cap: 47%
Tax-free component of genuine redundancy: No withholding.
The complexity here is why payroll software is essential — manually calculating the correct withholding across multiple components is error-prone, and errors affect the employee's tax liability.
STP Reporting for Termination Payments
Under STP Phase 2, termination payments must be disaggregated and reported in the period of payment. The income type for ETPs is specific — ETP components must be reported separately from ordinary wages.
For the departing employee's income statement to be correct (which determines what they can see in myGov and what their tax agent uses for their return), the STP data must accurately reflect:
- Regular wages for hours worked in the final period
- Each component of the termination package (unused leave, ETP, redundancy) as separate line items
- Correct withholding amounts for each component
After the termination is processed through payroll, reconcile the employee's year-to-date figures in STP against what was actually paid before marking the employee as terminated in the system.
Coding in the Books
Termination payments should be coded as follows:
Unused annual leave paid out: Wages expense (same as regular wages — this is not an ETP for accounting purposes)
Unused long service leave paid out: Wages expense or a dedicated long service leave expense account, depending on how the practice is set up. If the business has a long service leave provision on the balance sheet, the payout reduces that provision.
Payment in lieu of notice: Wages expense
Genuine redundancy payment (tax-free component): Redundancy expense — this is above the ordinary wages expense and should be disclosed separately in management accounts
ETP proper: Redundancy/termination expense
The PAYG withholding on all components is treated as payroll withholding — no different from regular payroll withholding from an accounting perspective.
What the Employee Receives
For the employee's records, they should receive an income statement (via myGov) showing all components separately. Where a payment summary used to be issued, it is now replaced by the STP finalisation process.
If the termination involves a genuine redundancy or an ETP, consider providing the employee with a written breakdown of the components and the applicable tax treatment. Many departing employees (and their personal accountants) are not familiar with the complexity of termination payment taxation, and a clear explanation prevents confusion and disputes.
Common Mistakes to Avoid
Including ETP amounts in gross wages. ETPs are not wages — they should not be included in the W1 gross wages figure on the BAS or treated as ordinary payroll.
Applying the wrong withholding rate. The most common error is applying marginal rates to all termination amounts. Annual leave and long service leave have flat rate withholding; ETPs have concessional rate withholding.
Missing the genuine redundancy tax-free threshold. Not calculating and applying the tax-free component means the employee overpays tax at source — they'll get it back in their tax return, but it creates avoidable confusion.
Incorrect STP reporting. If termination amounts are coded into wrong STP categories, the employee's income statement will be incorrect, and the ATO may flag discrepancies when the personal return is lodged.
Termination payments are rare events in most payroll cycles, which is exactly why the procedures tend not to be second nature. Keeping a reference checklist for termination payments — and reviewing it before processing rather than relying on memory — is good professional practice.