Payment in Lieu of Notice (PILON) Tax 2026/27: What Actually Gets Taxed
PILON is fully taxable as normal employment income, unlike some other elements of a leaving package. Here's exactly how PAYE and NI apply, and how PILON interacts with the £30,000 tax-free termination payment exemption.
Why PILON Tax Rules Changed in 2018
Before April 2018, the tax treatment of payment in lieu of notice depended heavily on whether your employment contract contained an explicit PILON clause:
- Contractual PILON (clause existed) — always taxed in full as earnings.
- Non-contractual PILON (no clause, employer simply chose to pay you out rather than have you work notice) — could sometimes be treated as damages for breach of contract and paid partly or wholly tax-free within the £30,000 termination exemption.
This created an obvious incentive for employers to deliberately avoid contractual PILON clauses, so that any notice buy-out could be structured more tax-efficiently. HMRC closed this loophole from 6 April 2018: all PILON is now taxed as earnings, regardless of contract wording, via the Post-Employment Notice Pay (PENP) mechanism.
How PILON Is Taxed
| Element | Tax Treatment |
|---|---|
| PILON (or PENP if not contractual) | Full PAYE income tax + employee Class 1 NI + employer Class 1 NI, exactly as normal salary |
| Genuine redundancy/compensation payment | Tax-free up to £30,000; income tax only above that; employer (not employee) NI above £30,000 since April 2020 |
| Accrued but unused holiday pay | Taxed as normal earnings, no exemption |
| Statutory redundancy pay | Counts within the £30,000 exemption alongside any enhanced redundancy payment |
Worked Example: A Mixed Termination Package
Suppose you're made redundant with 3 months' notice, which your employer pays out in lieu rather than having you work. Your basic monthly salary is £4,000.
| Component | Amount | Tax Treatment |
|---|---|---|
| PILON (3 months' basic pay) | £12,000 | Fully taxed as earnings — PAYE + employee NI + employer NI |
| Enhanced redundancy payment | £15,000 | Falls within £30,000 exemption — tax-free |
| Statutory redundancy pay | £5,000 | Also falls within £30,000 exemption |
| Total exemption used (redundancy elements) | £20,000 | Within £30,000 — no income tax due on this portion |
| PILON | £12,000 | Fully taxable regardless of the exemption — taxed separately |
Note that the £12,000 PILON is taxed in full in addition to the £30,000 exemption being available for the redundancy elements — the two pots are calculated and taxed entirely separately. PILON never uses up any of your £30,000 allowance, but it also never benefits from it.
The PENP Formula (When Your Contract Is Silent on PILON)
Where your employment contract doesn't explicitly address payment in lieu of notice, HMRC requires your employer to calculate a Post-Employment Notice Pay figure using a set formula, broadly:
PENP = (Basic Pay for the last full pay period before notice ÷ number of days in that pay period) × number of unworked notice days − any contractual payment already treated as earnings for the notice period
This PENP amount is then taxed as earnings in full, and only the balance of the termination payment (if any) can potentially benefit from the £30,000 exemption. The rule exists specifically so that however a termination payment is labelled or structured, HMRC can identify and tax the "notice pay equivalent" portion correctly.
PILON vs Redundancy Pay: Side-by-Side
| Feature | PILON | Redundancy Payment (statutory + enhanced) |
|---|---|---|
| Tax-free element | None | Up to £30,000 |
| Employee NI | Yes, in full | No, on any part |
| Employer NI | Yes, in full | Only on the amount above £30,000 (since April 2020) |
| Basis of calculation | Basic pay × unworked notice period (or PENP formula) | Statutory formula (age, length of service, weekly pay capped) plus any enhanced employer scheme |
Practical Takeaways for Anyone Leaving a Job
- Don't assume your whole termination package is tax-free up to £30,000 — PILON is calculated and taxed separately, on top of (not within) that exemption.
- Check your payslip breakdown carefully — a leaving payment often bundles PILON, redundancy pay, accrued holiday pay and sometimes a settlement/compromise agreement payment, each with different tax treatment.
- A settlement agreement doesn't change the PILON rule — even where a full and final settlement is negotiated, the notice pay element within it is still subject to the same PILON/PENP tax treatment; only genuine compensation for loss of employment can use the £30,000 exemption.
- Employer NI on amounts above £30,000 is an employer cost, not deducted from your payment — but it can influence how employers structure or negotiate the overall package size.
Frequently asked questions
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