Employee Termination Payments: Essential Legal Insights For Australia

Ending employment is rarely simple, but getting the money side right is essential for both employers and employees. In Australia, “termination payments” cover a few different categories - some are legally required, some are discretionary - and each has its own tax, superannuation and reporting treatment.

If you’re an employer, correct classification and clean documentation can prevent costly payroll corrections, penalties and disputes. If you’re an employee, understanding what you’re owed and why helps you check your final payslip with confidence.

Below, we break down the key concepts in plain English so you can manage employee termination payments the right way in Australia.

Important note: This guide provides legal information. It isn’t personal tax advice. Termination payments have complex tax rules - always confirm tax treatment and Single Touch Payroll (STP) coding with your accountant or the ATO. Sprintlaw provides legal support and documents; your registered tax or payroll adviser should confirm tax specifics.

What Are Employee Termination Payments (ETPs) In Australia?

Not every amount paid when a job ends is the same for tax or payroll purposes. Broadly, there are two main buckets you’ll be dealing with at the end of employment:

• Statutory entitlements that arise from law or agreement (for example, unused annual leave and long service leave). These are not ETPs and each has its own tax rules and reporting codes.
• Employee Termination Payments (ETPs), which are certain lump sums paid because employment ends (for example, a discretionary severance or “golden handshake”, compensation for loss of employment, or a payment in lieu of notice). ETPs are subject to caps, concessional rates within those caps, and specific STP codes.

Correctly identifying which bucket an amount belongs to drives how you calculate tax, whether superannuation applies, and how you report through STP. As a timing rule of thumb, most ETPs must be paid within 12 months of termination to access concessional ETP tax treatment; outside that window, they’re usually taxed at marginal rates.

A quick nuance to keep in mind: the source of an entitlement (contract, award or enterprise agreement) can affect whether an amount is “earned” as ordinary income versus a termination-related lump sum, but the ETP classification itself is determined under tax law and ATO guidance. In other words, how an industrial instrument labels a payment doesn’t, by itself, override the tax rules that define ETPs.

What Payments Are Usually Owed When Employment Ends?

What you must pay depends on the reason for termination (resignation, redundancy, dismissal, end of fixed term) and the employee’s entitlements under the Fair Work framework, any award or enterprise agreement and their contract. Here are the common components, and how they generally work.

1) Accrued But Unused Annual Leave

Employees are entitled to be paid out their accrued annual leave balance when employment ends. This is not an ETP. It’s taxed under specific unused leave rules and reported separately in payroll (include leave loading if applicable under the award or contract).

2) Long Service Leave (LSL)

Depending on your state or territory, accrued LSL may be payable after a qualifying period or on a pro‑rata basis if employment ends earlier. Like annual leave, LSL payouts are not ETPs and have their own tax treatment that can vary based on service length and when the leave accrued.

3) Redundancy Pay (Genuine Redundancy)

Where a role is genuinely no longer required, redundancy pay may be owed (separate from notice). Genuine redundancy payments can include a tax‑free portion up to an ATO‑indexed limit. Any amount above that may be taxed as an ETP. Keep genuine redundancy amounts and leave payouts as separate calculations - they’re handled differently for tax.

4) Notice Or Payment In Lieu Of Notice

If you don’t require an employee to work their notice period, you may pay them instead. A payment in lieu of notice is commonly treated as an ETP for tax purposes (subject to specific circumstances). Whether superannuation applies will depend on the character of the payment - we cover super considerations below.

5) Bonus And Commission

Accrued commissions or a bonus genuinely earned prior to termination are usually ordinary income, not an ETP. If you pay a discretionary gratuity simply because employment is ending (and not for work already performed), that amount may form part of an ETP. The contract or incentive plan terms and when the entitlement crystallises will matter.

6) Ex Gratia Or “Golden Handshake”

Any discretionary severance paid due to the end of employment is commonly an ETP and will be subject to caps and concessional rates within those caps.

7) Other Amounts

• Accrued but unpaid ordinary wages to the final working day.
• Leave loading, if applicable.
• Reimbursements for legitimate business expenses submitted on time.

Practically, many employers prepare a single statement of final pay that itemises each component with its tax and STP treatment. This improves transparency for the employee and reduces the likelihood of pay‑run errors.

How Are Termination Payments Taxed And Reported?

Australian tax rules group termination amounts into categories with different rates and reporting codes. Here’s the high‑level view you can brief payroll on (and then have your tax adviser confirm).

ETP Tax Treatment (Caps And Concessional Rates)

ETPs (for example, certain discretionary severance amounts, payments in lieu of notice, compensation for loss of job) are taxed at concessional rates up to an indexed ETP cap, and also interact with a whole‑of‑income cap depending on the payment type and the employee’s age. Amounts above the relevant cap are taxed at the top marginal rate. ETPs paid more than 12 months after termination generally lose concessional treatment and are taxed at marginal rates.

Genuine Redundancy And Approved Early Retirement

For a genuine redundancy or under an approved early retirement scheme, a portion of the payment may be tax‑free up to a formula‑based limit published annually by the ATO. Keep the tax‑free genuine redundancy component separate to any ETP calculation - the remainder, if any, may then be taxed as an ETP.

Unused Leave Payouts

Unused annual leave and long service leave have their own tax rules and are not ETPs. The rate can depend on when the leave accrued and the reason for termination, so it’s worth double‑checking your payroll configuration and the employee’s service history before you run the final pay.

STP Reporting And Payment Summaries

Under STP Phase 2, you’ll report the termination details (including reason codes) and classify ETPs using the correct code (for example, code R or O, as relevant). Accurate coding matters - it affects ATO processing and the employee’s tax outcome. If you’re unsure which code applies, pause the pay‑run and get tax advice before finalising.

Practical Tip

Have a second set of eyes review the numbers before you process the termination. A quick cross‑check of caps, codes and timing can prevent weeks of amendments and employee frustration later.

Do You Pay Superannuation On Termination Amounts?

Superannuation is generally calculated on Ordinary Time Earnings (OTE). Many termination amounts fall outside OTE - but not all. The key is to look at the nature of the payment and when the entitlement arose. Because this area can be nuanced, align your approach with current ATO guidance and your payroll adviser’s view.

When Super Usually Does Not Apply

• Unused annual leave and unused long service leave payouts are typically not OTE.
• Genuine redundancy payments are not OTE.
• Discretionary severance or gratuity amounts that are ETPs are generally not OTE.

Payment In Lieu Of Notice

Whether superannuation applies to a payment in lieu of notice depends on how the entitlement arises and how it’s characterised. Many such payments are treated as outside OTE, but it’s important to check your specific facts and award or agreement settings. For a deeper dive, review your position on superannuation on termination payments and confirm with your payroll provider or accountant.

Bonuses And Commissions

Amounts earned for ordinary time before termination (for example, accrued commissions or an earned short‑term bonus) may still be OTE. Again, it turns on when the entitlement crystallised and what it rewards.

Two-Minute Super Sense‑Check

• Ask: is this payment for ordinary hours worked? If yes, super may apply.
• Ask: is this payment solely because the job ended (for example, a discretionary severance)? If yes, it’s usually not OTE.

When in doubt, get written confirmation from your tax adviser and note it on the payroll file.

Managing The Process, Paperwork And Risk

The amounts are only one piece of the puzzle. A clear process and the right documents help close out obligations and minimise disputes.

Plan The Timeline And Communicate Clearly

Confirm the last working day, notice (or payment in lieu), handover tasks, equipment return and payroll cut‑off dates in writing. Tell the employee what they will be paid, the expected pay date, and what will be deducted (for example, lawful deductions for unreturned property if allowed under the contract).

Calculate Each Component Separately

Work out unused leave, LSL, notice or payment in lieu of notice, redundancy, commissions/bonuses and any ex gratia amounts as separate line items. This supports correct tax and STP coding and makes reconciliation easier if adjustments are needed. If your team wants a checklist approach, map the items you include in final pay against your payroll system’s categories before processing.

Use The Right Agreements

Where employment ends by mutual agreement, or you’re paying amounts beyond strict statutory entitlements, consider documenting the arrangement in an Employee Separation Agreement. This can record final payments, confidentiality and non‑disparagement terms, return of property and post‑employment obligations.

If claims are being settled, a tailored Deed of Release is usually appropriate. Careful drafting ensures the release is enforceable and consistent with workplace laws.

Follow A Fair Process

Paying entitlements isn’t the whole story - the dismissal process itself should be fair. Consider issues like valid reason, notification, an opportunity to respond and whether a support person was allowed. These are the kinds of factors reflected in Section 387 of the Fair Work Act. A sound process reduces the risk of unfair dismissal claims and costly settlements.

Standardise Your Templates And Checklists

If you handle terminations regularly, standard letters, calculators and checklists can save time and reduce errors. Many teams keep a suite of employee termination documents ready to go, so every termination follows the same clear steps.

Common Edge Cases To Watch

• Probationary Periods: Short service doesn’t remove the need to pay lawful entitlements or follow contractual notice requirements. Be consistent and document decisions.
• Overpayments: If a payroll mistake occurs, correct it quickly and use a lawful recovery process. This reduces the risk of unlawful deductions and preserves trust.
• Garden Leave: If contracts allow, you can direct an employee to stay away from work during notice on full pay to protect clients and confidential information. Payroll treatment remains ordinary; garden leave is an operational setting, not a special payment type.

Key Takeaways

• Different termination amounts are treated differently: ETPs (such as discretionary severance or a payment in lieu of notice) sit apart from unused leave payouts, which have their own tax rules and STP codes.
• Genuine redundancy can include a tax‑free portion up to an ATO‑set limit; any excess may be taxed as an ETP. Keep redundancy components and leave payouts separate in your calculations.
• Superannuation generally doesn’t apply to unused leave, genuine redundancy or most ETPs, but may apply to amounts earned for ordinary time - confirm your position on superannuation on termination payments with your payroll adviser.
• Accurate classification, caps and STP coding are critical. A brief pre‑pay‑run review can prevent corrections and employee frustration later.
• Use clear documentation - from termination letters to an Employee Separation Agreement or a Deed of Release - to reduce disputes and close out obligations cleanly.
• Process matters: following fair steps aligned with Section 387 reduces legal risk alongside paying the correct amounts.
• Tax is complex - confirm the treatment and coding of termination payments with your accountant or the ATO before finalising payroll.

If you’d like a consultation on handling employee termination payments and the right documents for your business, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no‑obligations chat.