NICs on Settlement Payouts: When You Pay and When You Don’t

When a dispute between an employee and employer ends with a large settlement, one of the first tax questions is whether Class 1 National Insurance contributions (NICs) apply. The answer depends entirely on the nature of the payment and the reason it was made.

When Settlements Are NIC-Free

If a settlement is paid only as compensation for a loss—like avoiding a lawsuit for unfair dismissal, injury, or discrimination—it is usually not considered earnings. These payments are made to settle disputes without admitting fault and are not tied to any work done or services provided.

In such cases:

• The payment is not remuneration for employment.
• It is treated as damages, not wages.
• No Class 1 NICs are payable by either party.

When NICs Apply

Not all settlements escape NIC liability. NICs can be due when the payment is:

1. Directly linked to termination — e.g., compensation connected to the ending of employment.
2. A payment in lieu of notice (PILON) — now always taxable and NIC-able unless the full notice is worked.
3. Above the £30,000 tax-free threshold for termination payments, where Class 1A NICs are due from the employer.
4. Remuneration disguised as damages — if the payment effectively replaces salary or bonuses.

Mixed Payments and Apportionment

Many settlement agreements combine different elements—compensation, notice pay, accrued holiday, and benefits.

To manage NIC exposure:

• Clearly label each payment component in the agreement.
• Separate taxable from non-taxable amounts.
• Avoid wording that ties compensatory payments too closely to employment terms.

Practical Tips for Employers and Employees

• Document the reason for the payment clearly—especially if it is genuinely compensatory.
• Check the £30,000 exemption for termination payments and watch for Class 1A NIC triggers.
• Review PILON clauses in contracts to avoid automatic NIC liability.
• Seek professional advice before finalising wording—small changes can make a big difference to the NIC outcome.

Settlement payments are not automatically subject to NICs. If the payment is truly compensatory and unrelated to employment or termination terms, it can remain NIC-free. But once the link to employment is established—particularly with notice pay or contractual obligations—NICs often apply. A well-structured settlement agreement not only resolves disputes but also optimises the tax and NIC position for both parties.