Redundancy pay for Americans in Britain: why the £30,000 exemption stops at the border

Figures relate to tax year 2025-26 (UK) / 2025 (US)

Redundancy pay in Britain comes with a generous break: the first £30,000 is free of income tax and National Insurance. Many Americans assume the IRS follows suit. It does not, and the difference can turn a tax-free payment into a real US bill.

Usually a relief exists to cover it, but which one depends on your wider tax position. So this guide explains how each country treats the payment, and how to stop the same money meeting tax twice.

Key takeaways

• HMRC exempts the first £30,000 of qualifying termination payments.
• The IRS treats the whole payment as taxable compensation.
• Severance for UK work usually counts as foreign earned income.
• Excess UK tax credits from your salary often cover the tax-free part.
• Payment in lieu of notice is fully taxable in both countries.

What is redundancy pay for tax purposes?

Redundancy pay is a payment made because your job ends, rather than for work you performed. That distinction drives the UK treatment. Payments that replace wages you would have earned, such as notice pay, fall outside it and stay fully taxable.

Statutory redundancy pay depends on your age, your years of service and a weekly pay cap. Many employers pay an enhanced amount on top. Both sit inside the same £30,000 exemption, which covers the combined total.

HMRC looks at why the money was paid. The IRS looks at what it was paid for.

How does HMRC tax the payment?

The first £30,000 of qualifying termination payments is free of income tax and employee National Insurance. Anything above that is taxed as employment income at your marginal rate. According to the GOV.UK guidance on redundancy pay (opens in a new tab), statutory pay also follows set calculation rules.

Several items sit outside the exemption entirely. Notice pay, whether worked or paid in lieu, is taxable in full. So are holiday pay, bonuses and any wages owed to your final day.

Your employer applies the exemption through payroll. Check the final payslip carefully, because the split between exempt and taxable elements is exactly what you will need for your US return.

Why does the IRS tax the full amount?

Because US law has no equivalent exemption. Severance counts as compensation connected to your employment, taxable in the year you receive it. America never recognises the British rule, however large the package.

Emotional distress settlements follow the same logic. US law excludes damages only for physical injury or sickness, so compensation for injury to feelings is usually taxable in America even where Britain treats it differently.

Does the foreign earned income exclusion cover it?

Often, yes. Severance attributable to work you performed in Britain generally counts as foreign earned income. If you qualify for the exclusion, you can exclude the package alongside your salary, up to the $130,000 limit for 2025.

Timing complicates the picture. The payment belongs to the period in which you earned it, and income received more than a year after that period cannot be excluded at all. Per the IRS guidance on the foreign earned income exclusion (opens in a new tab), the limit also applies to the year the income was earned.

Watch the limit carefully in your final year. A full salary plus a large package can exceed $130,000, leaving part of the package exposed. Our guide to Form 2555 and the exclusion explains how the limit works.

How can UK tax credits cover the gap?

Most Americans in Britain pay more UK tax than the US would charge on the same salary. That surplus creates excess foreign tax credits. Because salary and severance fall in the same category of income, the excess can shelter the tax-free portion of the payment.

In practice this often wipes out the US bill entirely. Someone earning £90,000 who receives £30,000 of tax-free redundancy pay may still owe nothing in America, because the UK tax on the salary covers both. Unused credits from earlier years can also help.

Our guide to Form 1116 and the foreign tax credit explains the categories and the carryover rules that make this work.

Does National Insurance count on your US return?

Not as a credit. UK National Insurance is a social security contribution covered by the US UK totalization agreement. Contributions covered by that agreement cannot be claimed as foreign income tax, so they do nothing to reduce your US bill.

That rarely matters for the tax-free part, since it carries no National Insurance anyway. It matters more for notice pay and the final salary, where people sometimes add the contributions to their UK tax figure by mistake.

Garden leave and final salary

Pay during garden leave is ordinary salary in both countries. You remain an employee, so HMRC taxes it through payroll and the IRS treats it as wages.

For the exclusion, garden leave pay still counts as foreign earned income if you live in Britain at the time. Days spent on garden leave abroad also count toward the physical presence test. Keep the garden leave dates with your records, since they fix when employment actually ended in both countries.

How do you report redundancy pay properly?

Start from the final payslip and the settlement agreement, because together they show what each payment was for. Keep both documents side by side. Then work through the US position in this order:

1. Separate the package into redundancy pay, notice pay, holiday pay and bonuses.
2. Note the exempt and taxable figures from the final payslip.
3. Convert each element to dollars using the rate on the payment date.
4. Decide whether the exclusion or the credit gives the better result.
5. Check the exclusion limit against salary and severance combined.
6. Apply any excess or carried-over credits to the remaining US tax.
7. Keep the settlement agreement with your tax records.

Can you pay part of the package into a pension?

Often, and it can suit both countries. An employer contribution to a registered UK pension carries no UK tax or National Insurance. Many employers will redirect part of a severance package this way if you ask before the paperwork is final. The saving is largest above the £30,000 line, where the money would otherwise meet income tax at your marginal rate.

The US side needs more care. The treaty can protect employer contributions to a British scheme from US tax, but the conditions are technical. Model the position before agreeing, because a contribution that fails the conditions becomes taxable income in America.

Share awards that vest when you leave

Redundancy often accelerates the vesting of restricted stock units. The shares become taxable when they vest in both countries, and the US sources the income across the years you worked toward them.

That sourcing decides how much counts as foreign income, which in turn drives the credit. Our guide to share schemes across two countries explains the vesting trap in detail.

A worked example

Take an illustrative example. An American engineer in Reading is made redundant in November 2025 after eight years. His package includes £30,000 of statutory and enhanced severance, £9,000 of payment in lieu of notice, and his normal salary to date of £75,000.

HMRC taxes the salary and notice pay, and leaves the £30,000 alone. The IRS taxes all three. Using the foreign tax credit, his UK tax on £84,000 of taxable pay produces enough excess credit to cover the US tax on the package.

His US bill for the year is nil. Had he used the exclusion instead, salary and severance together would have approached the limit, leaving little room and forfeiting credits worth carrying forward. Those unused credits then remain available for later years.

What if you move back to America afterwards?

The payment still relates to your British job, so it generally keeps its foreign source. That matters because the foreign tax credit and the exclusion both depend on foreign earned income, not on where you live when the money arrives.

State tax is the new risk. A state you move to may try to tax a payment received after arrival. Our guide to moving back to the US covers the state position and the timing of your return.

Mistakes and traps with redundancy pay

These errors turn a covered payment into an avoidable bill. Each appears regularly in returns we review:

• Leaving the tax-free £30,000 off the US return entirely.
• Treating payment in lieu of notice as part of the exemption.
• Using the exclusion without checking the limit against salary and severance combined.
• Ignoring excess foreign tax credits that would cover the payment.
• Assuming a settlement for injury to feelings is tax-free in America.
• Forgetting a state claim after returning to the US.

Pension contributions can change the numbers too. Some employers let you pay part of the package into a workplace pension, which can suit both countries when handled properly.

How US UK Tax Accountants helps

We split the package into its parts, model the exclusion against the credit, and file the result that leaves the most in your pocket. Our US federal returns service covers the redundancy year alongside your UK return.

In our practice the best outcomes come from reviewing the settlement agreement before you sign it. We agree a fixed fee in writing before any work starts.

Check your package before you sign

If you are facing redundancy in Britain, a short review protects the tax-free part of your package on both sides. Send us the settlement terms and your recent payslips. You can book a consultation and hear back within one working day.

Last reviewed 14 September 2026 by the US UK Tax Accountants Tax Team. This article is general information, not personal tax advice — speak to a qualified US/UK tax adviser about your own position.