Employee Termination Payments: What Employers Must Know

Employee termination is never easy - emotionally, legally, or financially. But what often creates the most confusion for employers is employee termination payments. What must be paid? What’s optional? What’s taxable? And what happens if you get it wrong?

Whether an employee resigns, is made redundant, or is terminated for other reasons, employers are legally and ethically responsible for settling all final dues correctly and on time. Mistakes here can lead to compliance issues, penalties, disputes, and damage to your employer brand.

This guide breaks down everything you need to know about employee termination payments - from types and calculations to tax rules and country-specific compliance - so you can handle terminations confidently, fairly, and lawfully.

What are employee termination payments?

At its simplest, an employee termination payment (ETP) is the lump sum paid to an employee when they leave a job. However, it’s not a single "type" of money. It is an umbrella term for various entitlements an employee has earned during their tenure or is legally owed because their employment is ending.

The goal of these payments is to bridge the gap for the employee as they transition to their next role and to fulfil the contractual and statutory obligations of the employer. These payments compensate the employee for:

• Work already completed
• Benefits earned but not yet paid
• Contractual or statutory entitlements
• Loss of employment (in some cases)

Termination payments may apply regardless of whether the employee resigns, is dismissed, made redundant, or exits through mutual agreement. The structure and amount of these payments depend on employment contracts, company policies, and local labour laws.

Related topic: How to Announce Layoff News to Staff

Types of termination payments

Employee termination payments are rarely a single payout. They usually consist of multiple components, each governed by different rules. As a result, not every departing employee gets the same package. The "what" and "how much" depend heavily on the reason for leaving. 

Severance

Severance pay is compensation provided to employees when their role ends due to reasons beyond their control, such as layoffs or business restructuring. It is often intended to provide financial support while the employee searches for new work.

Severance may be required by law in some countries, while in others it is offered based on company policy or employment agreements. The amount is commonly calculated based on the employee’s length of service and salary.

Accrued Leave

In most jurisdictions, employees must be paid for the time they’ve earned but haven’t used. This includes:

• Annual leave/VAC: Unused vacation days.
• Long service leave: Specific to places like Australia, where long-tenured staff get extra paid time off.
• Sick leave: Usually, sick leave isn't paid out unless specified in a contract, but it's important to check local laws.

Redundancy

Redundancy payments apply when an employee’s position is eliminated due to operational or economic reasons, not because of performance or misconduct. These payments recognise the involuntary nature of the job loss.

In many regions, redundancy pay is legally mandated and calculated based on tenure, age, and earnings. Employers must follow strict rules, especially during mass layoffs or restructurings.

Bonus or commission payouts

Bonus and commission payments can complicate termination processes, especially when performance periods are incomplete. Employers must carefully assess whether these payments have already been earned.

If a bonus or commission is contractually guaranteed or tied to completed work, it usually must be paid - even after termination. This is particularly important in places like the US, where bonuses are often treated differently from regular wages and can affect how much tax is withheld at payout.

Note: Check your "active employment" clauses. Some contracts state that an employee must be employed on the date of the payout to receive a bonus. Be careful, as these clauses are often challenged in court.

Local compliance requirements (US, UK, EU, AU)

Employee termination payments are heavily influenced by local labour laws, which vary widely across countries. Employers operating globally must understand that one-size-fits-all approaches do not work.

Failure to comply with country-specific requirements can lead to fines, employee claims, and regulatory scrutiny.

United States

No federal law requires severance. However, final paycheck laws vary by state (e.g., California requires immediate payment upon termination). 

United Kingdom

Focuses on statutory redundancy pay for employees with 2+ years of service. There are strict caps on the weekly amount (£719 per week as of recent limits).

European Union

Very worker-centric. Often involves long notice periods (up to 6 months) and high mandatory severance packages based on collective bargaining agreements.

Australia

Highly regulated via the National Employment Standards (NES). Specific rules apply to "genuine redundancy" and strict tax reporting through “single touch payroll”.

Tax rules for termination payments

You can't just write a check for the gross amount. Governments treat different parts of a termination payment differently:

• Standard income: Unused holiday pay and final wages are usually taxed at the employee's normal income tax rate.
• Tax-free thresholds: In many countries (like the UK and Australia), a portion of a redundancy payment may be tax-free up to a certain dollar limit.
• Withholding: Employers are responsible for calculating and withholding the correct amount of tax. Over-withholding frustrates the employee; under-withholding gets you audited.

How to calculate termination payments

Calculating employee termination payments requires a systematic approach. Employers must account for multiple payment components and apply the correct formulas. To ensure accuracy, follow these key steps: 

1. Identify the termination reason
2. Review employment contract and policies
3. Confirm statutory entitlements
4. Calculate outstanding salary
5. Add accrued leave balances
6. Include severance or redundancy (if applicable)
7. Apply correct taxes and deductions

Common mistakes employers make

Even well-intentioned employers often make mistakes when handling employee termination payments. These errors usually happen because termination processes are rushed, laws are misunderstood, or payroll teams rely on assumptions instead of verified rules.

Unfortunately, mistakes in termination payments can quickly escalate into employee disputes, legal claims, penalties, or audits. Below are the most common errors employers make.

Missing statutory payments

One of the most serious mistakes employers make is failing to pay mandatory, legally required amounts. These may include notice pay, redundancy pay, or unused leave that must be settled by law.

Incorrect tax deductions

Termination payments are taxed differently depending on the payment type, country, and reason for termination. Employers frequently apply a flat tax rate to all components, which can be incorrect.

Late final payments

Many countries require final termination payments to be made within a specific timeframe - sometimes on the employee’s last working day or within a few days after termination.

Ignoring local notice rules

Notice periods and notice pay are strictly regulated in many regions. Employers sometimes assume that paying a salary until the last working day is enough, even when additional notice pay is legally required.

Misclassifying bonuses or commissions

Bonuses and commissions are often misunderstood during termination. Employers may assume these payments are discretionary and withhold them, even when they have already been earned.

Failing to document calculations

Another frequent mistake is not documenting how termination payments were calculated. Without clear records, employers struggle to defend themselves if an employee raises questions or files a complaint.

Best practices for managing termination payments

Managing employee termination payments effectively requires preparation, consistency, and clear communication. A well-defined process reduces risk and improves employee experience.

• Create a standardised termination process.
• Maintain up-to-date employment contracts.
• Stay informed on local labour laws.
• Use automated payroll tools where possible.
• Provide clear payslips and breakdowns.
• Communicate timelines transparently.

Employer checklist

A structured checklist helps ensure nothing is overlooked during the termination process. It also provides consistency across teams and regions. So, before you hit "send" on that final payment, check these boxes:

• Notice period: Has the employee worked their notice, or are you paying them "in lieu" of notice?
• Accrued leave: Have you verified the balance in your HRIS system?
• Expense reports: Have all outstanding business expenses been reimbursed?
• Company property: Have laptops, keys, and credit cards been returned? (Note: In many places, you cannot withhold pay just because a laptop is missing).
• Final statement: Have you issued a pay stub that clearly labels "ETP" components?

Final note

Employee termination payments are often the last interaction an employee has with your company - but they’re also one of the most telling. Get them right, and you close the chapter with professionalism, fairness, and trust. Get them wrong, and that final moment can quickly turn into a dispute, a complaint, or a compliance headache.

Treat termination payments as a process, not a payout. When you approach them with clarity, structure, and respect for local laws, even difficult exits can end on a solid note. Because in the end, how you say goodbye matters just as much as how you hire.