Only the genuine redundancy component calculated under the ATO's indexed formula is tax-free, up to the whole-of-income cap. The rest of the package is taxed under ordinary PAYG rules or employment termination payment, depending on what each part of the payout is for.
A lot of people open a redundancy letter and assume the headline figure is either all tax-free or all taxable. That's the wrong way to read it. The ATO looks at the mix inside the package, not just the total.
Who this article is for: employees, HR leads, and new migrants who have received, or are about to receive, a termination package in Australia.
Currency note: This article reflects Australian rules, thresholds and regulator guidance current as at 08/2026.
Table of Contents
- When a Sydney Payout Lands in Your Account
- What the ATO Means by Genuine Redundancy
- The Indexed Tax-Free Formula and the Caps That Sit Above It
- Which Parts of the Payout Are Not Tax-Free
- A Worked Example for Wei in Sydney
- Reporting, Elections and What to Do Before You Sign
- What to Carry With You and Where the Answer Bends
When a Sydney Payout Lands in Your Account
A Sydney manager gets called into a meeting, is told the role no longer exists, then gets a termination letter with several lines on it and a lump-sum figure at the bottom. The right question isn't “are redundancy payments tax free”, it's which part is genuine redundancy compensation and which part is just final pay.
Only the genuine redundancy component, calculated under the ATO's indexed formula and subject to the relevant cap, can be tax-free. The rest of the termination package is taxed under ordinary PAYG rules or as an employment termination payment, depending on its character and timing. The ATO's own genuine redundancy guidance makes the same distinction, and anything above the tax-free limit moves into the ETP rules rather than staying exempt (ATO genuine redundancy payments).
This article is for people who want the payout read in plain English before they sign anything. If you're an employee, an HR lead, or a new migrant trying to work out what lands in your bank account and what lands in the tax return, read the breakdown, not just the cover letter.
Practical rule: don't ask whether the redundancy is tax-free in the abstract, ask how much of the package is genuine redundancy compensation, how much is leave, how much is notice pay, and whether an ETP cap is in play.
Use this exact tax lens when you compare offers or settlement deeds, because the answer changes with the makeup of the package. For a broader payroll context, see the related discussion on whether you should claim the tax-free threshold.
What the ATO Means by Genuine Redundancy
The ATO looks first at why the job ended. A genuine redundancy exists where the employer no longer needs the employee's role, and the dismissal flows from the role disappearing, not from conduct, performance, or a sideways move into a substantially similar job. The tax concession follows that loss of employment, not the wording used in the letter.
A payment tied to the employee's own conduct, or a transfer of business where a substantially similar role is still on offer, does not get the same treatment. Once the payment stops being genuine redundancy compensation, it stops accessing the tax-free formula and starts being dealt with as ordinary income or an ETP component instead. The ATO's genuine redundancy guidance says the tax-free treatment is limited, and any amount above that limit is treated under the employment termination payment rules (ATO genuine redundancy payments).
For employers, this is not paperwork trivia. It affects withholding, reporting, and how the final statement is coded. If the separation certificate does not clearly support redundancy, the tax treatment can go down the wrong path.
The cleaner test is simple. Did the role disappear from the business, or only the person from the role? That question usually tells you more than the heading on the letter. If the paperwork is messy, the employment law and payroll crossover is worth reviewing through employment law compliance guidance.
If you are preparing for the settlement conversation, virtual interview AI coaching can help you frame the questions to ask about the payout split.
The Indexed Tax-Free Formula and the Caps That Sit Above It
The ATO's tax-free formula is mechanical, and that helps when you are splitting a termination payment. For the 2025 to 26 income year, the tax-free amount is $12,524 plus $6,264 for each completed year of service. For the 2026 to 27 income year, the indexed figures rise to $13,598 plus $6,801 for each completed year of service.
| Component | Tax Treatment | Key Threshold |
|---|---|---|
| Genuine redundancy amount within the formula | Tax-free | Current formula limit for the relevant income year |
| Amount above the formula limit | Taxable as an ETP | Subject to the ATO's ETP cap and whole-of-income cap |
| Leave, notice pay, bonus, salary-like entitlements | Taxed as ordinary income | PAYG applies under ordinary rules |
The caps are separate, and they do different jobs. The whole-of-income cap of $263,000 is a separate benchmark used for genuine redundancy treatment in the 2025 to 26 income year, and the ATO also uses the ETP cap to decide whether concessional ETP tax rates can apply to the taxable part of the redundancy payment. The practical point is simple, the higher the genuine redundancy component, the more can sit inside the formula. The more of the package that is leave or earnings, the more is taxed at standard rates.
A prior termination payment can still affect the result. Do not assume the current payout gets a fresh tax concession just because the new redundancy looks modest on its own. The relevant cap can still bite. If you want a plain-English framework for why classification matters more than gross amount, see taxable income formula guidance.
For clients comparing overseas material to Australian rules, it helps to keep the pieces in separate buckets rather than call the whole package one lump sum. That same discipline is useful when reviewing what your business owes the IRS, even though the Australian rules are different.
Bottom line: the formula gives you the tax-free slice, but the caps decide whether that slice is fully available in your circumstances.
Which Parts of the Payout Are Not Tax-Free
Unused annual leave, long service leave, pay in lieu of notice, bonuses, commissions, and other salary-like entitlements sit outside the redundancy tax-free treatment. They are worked out separately, and payroll usually withholds tax under ordinary PAYG rules.
The split matters because each item has its own tax character. Amounts earned from work already done, or entitlements that have already accrued, are taxed as income. Genuine redundancy compensation is the separate piece that can fall under the concession, while leave and salary-like payments stay in the ordinary tax net. That is the part people get wrong when they look only at the total payout.
A termination package often carries several tax labels in one envelope. Payroll teams should separate those labels before withholding starts, not after the payslip has been issued. If you want the employer-side rules on withholding, the position is set out in PAYG withholding obligations.
Practical rule: if the payment would still be owed even when the role had never been abolished, it is usually not tax-free redundancy compensation.
Employer pension contributions and some non-cash items can also be treated on their own facts. Read the whole deed, not just the termination summary. For keeping the paperwork that supports the tax treatment, how long to keep important documents is a practical guide.
A Worked Example for Wei in Sydney
Wei has a genuine redundancy package sitting inside a broader termination payout. That split decides the tax outcome. His package is $180,000 in total, made up of $120,000 genuine redundancy compensation, $35,000 unused leave, $15,000 in lieu of notice, and $10,000 accrued bonus. The ATO does not treat that envelope as one lump sum.
Under the 2025 to 26 formula, Wei's tax-free redundancy amount is $12,524 plus 8 x $6,264, which equals $62,636. Using the ATO employment termination payments rules, that is the amount that sits in the tax-free redundancy bracket for this example. The rest of the genuine redundancy component, $57,364, moves into ETP treatment.
Wei's residency status adds a separate layer. As a new migrant, he needs the pay period and tax residency position checked against the final payroll coding, because the employer has to report the payment under the correct label from the start. A separation certificate that describes the payout accurately matters here, especially if the deed gives the payroll team more than one way to code the termination.
The other items stay outside the tax-free redundancy calculation. Wei's $35,000 leave payout, $15,000 notice payment, and $10,000 bonus are taxed at marginal rates under PAYG, because they are leave, notice, and bonus amounts rather than the redundancy concession itself. If payroll mixes those items together, the tax result will be wrong.
For the paperwork trail, keep the deed, the payroll advice, the separation certificate, and the final payslip together. If the numbers later look wrong, those documents are what lets you fix the classification, and the note on how long to keep important documents is the one to follow. If you want a qualified adviser to check the split before you sign, use these tax agent qualifications as the benchmark.
Reporting, Elections and What to Do Before You Sign
The employer must report the genuine redundancy component and any ETP on the income statement and payment summary. The employee then has to deal with the ETP component correctly in the return, including the choice between the low-rate cap and the whole-of-income cap where relevant. That choice can change the final tax payable, so it should be checked before the paperwork is signed off.
Timing matters as well. If the payment is made within the relevant termination window, the ETP rules can apply in the intended way. If a previous employer has already used part of the whole-of-income cap, that can narrow the concessional space on the current payment. New migrants also need to check tax residency and the pay period that applies, because those facts affect how the ATO allocates the payment across the return.
Keep the deed, the payroll advice, the separation certificate, and the final payslip together. If the numbers later look wrong, those documents are what lets you fix the classification.
Hold onto the records until you are certain the split is right, and then keep them with the rest of your tax file. The guide on how long to keep important documents is a useful prompt for what to preserve before you lodge anything. For adviser qualifications and the standard you should expect from the person reviewing the split, see tax agent qualifications.
What to Carry With You and Where the Answer Bends
The core answer is simple. The tax-free part of a genuine redundancy is the ATO formula amount, capped by the whole-of-income limit, and everything else in the package is taxed as an ETP or at marginal rates depending on what it is. What changes the outcome is the number of completed service years, any prior ETPs, the leave and bonus mix, and when the payment is made.
That is why the right answer depends on your circumstances, not just the redundancy label on the letter. If the deed splits the payment cleanly, the tax result is usually manageable. If it doesn't, the classification problem becomes the tax problem.
If you would like clarity on how these principles may apply to your own circumstances, contact Everglow on 1300 913 929 or email contact@everglow.au.
To book directly: Book a meeting with Panbo.
If you're sorting out a redundancy package, Everglow Prosperity can help you separate the tax-free component from the taxable parts, check the reporting, and make sure the paperwork lines up with the ATO rules. Visit Everglow Prosperity if you want a calm review before you sign or lodge.
Tags: Australian redundancy tax, ATO redundancy rules, genuine redundancy, employment termination payment, PAYG withholding, redundancy payout, Sydney tax advice, new migrant tax Australia
