The first £30,000 is tax free. Your American return has not heard of it

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

The job ended, the lawyers did their work, and the offer letter splits the money into neat categories. Notice pay here, a compensation payment there, a contribution to your legal costs at the bottom.

Those categories exist because British tax treats each part of a settlement agreement differently, and the first slice of genuine compensation can come to you tax free. A settlement agreement drafted for British tax does not translate. America looks at the same money and mostly sees income.

Key takeaways

• A settlement agreement can pay the first £30,000 of compensation tax free in Britain.
• America has no equivalent exemption and taxes most of it as income.
• Notice pay is taxable on both sides, so the credit works normally there.
• The exempt slice produces no British tax and therefore no credit to claim.
• Payments for injury to feelings are treated differently in each country.
• The split negotiated in the settlement agreement drives your American bill.

What is a settlement agreement?

A settlement agreement is a binding contract ending an employment relationship. You give up the right to bring claims in exchange for a payment. According to HMRC guidance, each element follows what it actually pays for, not the label the parties chose.

Independent legal advice is a condition of it binding you.

That advice covers British consequences. It rarely covers American ones.

How does Britain tax the payments?

In parts. Notice pay and accrued holiday count as ordinary earnings and carry full tax. Genuine compensation for loss of employment can attract an exemption on the first £30,000, and anything above that follows the normal rules.

Contractual bonuses and commission stay taxable throughout.

So the drafting is not cosmetic. It decides the British bill.

How does America treat the same money?

As compensation for services in most cases, taxed as ordinary income at your marginal rate. Per IRS guidance, amounts received in settlement of employment claims are generally taxable unless they compensate for physical injury or physical sickness.

The British exemption has no American counterpart at all.

So the slice your solicitor worked hardest to protect is the slice America taxes without relief.

Why does the exempt slice cost you most?

Because it carries no British tax to credit. A foreign tax credit relieves double taxation, and where Britain charged nothing there is nothing to set against the American charge. The taxable portions cause much less difficulty.

It is the same pattern as every tax-free British relief.

Our guide to the foreign tax credit explains the mechanics.

A worked example

The figures below are illustrative and use round numbers to show the mechanics.

Rachel, an American in Manchester, leaves her job with a package of £80,000. It splits into £20,000 of notice pay, £55,000 of compensation and £5,000 towards legal fees.

Britain taxes the notice pay in full, exempts £30,000 of the compensation and taxes the remaining £25,000.

America taxes roughly the whole £75,000 as income. The exempt £30,000 arrives with no British tax attached, so she pays American tax on it with no credit available at all.

How the elements compare

What about payment in lieu of notice?

Britain treats it as earnings, whether the contract provides for it or not. The rules exist to stop anyone recasting notice pay as compensation. So it stays fully taxable here, and fully taxable in America too.

This element causes the least trouble across the two systems.

The tax paid in Britain credits normally against the American charge.

Are injury to feelings awards different?

They are, and the two countries diverge sharply. Britain can exempt an award for injury to feelings arising from discrimination in certain circumstances. America generally taxes it, because emotional distress without physical injury does not qualify for its exclusion.

The narrow American exclusion needs physical injury or physical sickness.

Get the wording right in the agreement itself, since it is the only evidence you will have.

Document the basis of any such award carefully at the time.

What happens to the legal fees?

An employer contribution paid directly to your solicitor can be exempt in Britain where it covers advice on the agreement alone. America looks at whether the fees relate to taxable income, and the deduction rules for employees are restrictive.

Discrimination claims can sit differently from ordinary exits.

Ask your solicitor to invoice in a way that matches how the payment is described.

Ask the question before anyone addresses the invoice.

Can the agreement be drafted better for you?

Sometimes, within the bounds of what genuinely happened. The split must reflect reality, and neither country accepts a label chosen purely to cut tax. But you can still discuss timing and structure while the terms remain open.

Once you sign, the numbers stop moving.

So the useful conversation happens before signature, not afterwards.

Does a restrictive covenant payment count?

It does, and it sits outside the exemption entirely. A sum paid for agreeing not to compete or not to poach staff counts as earnings in Britain, and America treats it as income in the same way.

So no part of it enjoys the tax free slice.

Watch for it buried in the middle of the schedule.

What about shares and unvested awards?

They often form the largest part of a senior package and follow their own rules. Accelerated vesting on exit can create income in both countries, apportioned across the period the award was earned rather than the leaving date.

Payroll rarely handles that split correctly.

Our guide to US-UK share schemes covers the apportionment.

Is a tribunal award treated the same way?

Broadly, yes. What matters is what the award compensates for rather than whether a judge or a negotiation produced it. The same categories apply, and the same divergence between the two systems follows.

Costs awards sit separately again.

Settling before a hearing usually leaves you more room to agree the split.

Keep the judgment or the agreement itself, since it evidences the split.

How to review the offer

1. List every element in the offer and what each one is genuinely for.
2. Separate ordinary earnings from compensation for loss of employment.
3. Identify which elements attract British tax and which do not.
4. Convert each figure to dollars at the rate on the payment date.
5. Estimate the American charge, including the elements with no credit.
6. Check whether a payment during the year avoids an underpayment charge.
7. Raise any structural points with your solicitor before signing.

Does the timing of payment matter?

It can matter a great deal. The British tax year ends on 5 April and the American one on 31 December, so a payment in February lands in different years on each side and splits the income from the credit.

A large payment can also push you into a higher American bracket.

Ask whether the employer can pay in April rather than February. They often can.

Where the date is negotiable, it is worth modelling both options.

What if you leave the country afterwards?

Your residence at the time of payment matters for Britain, and your citizenship matters for America regardless. Somebody paid after leaving Britain may face a different British outcome, while the American position follows them wherever they go.

Moving does not remove the American charge.

Our guide to dual-status tax returns covers the year of a move.

Does it affect your pension contributions?

It can, where part of the package goes into a pension instead of your bank account. Britain often treats an employer contribution favourably, while America needs a treaty position before it gives any relief at all.

That route can still work well for a dual filer.

Check the annual allowance before directing a large sum into a scheme.

Our guide to employer pension contributions sets out the claim.

Does the employer withhold American tax?

No. A British employer operates British payroll and nothing else, so the payment reaches you with British deductions only and nothing at all set aside for America. That gap is what creates an underpayment charge later.

That is the gap that creates the underpayment charge.

Put the American share aside yourself when the money lands.

What records should you keep?

The signed agreement with its full breakdown, the payslip showing what the employer deducted, and your solicitor invoice. Those three documents between them evidence every figure that appears on either return, which matters if anyone asks later.

Keep them for at least six years.

A breakdown reconstructed later convinces nobody.

Should you tell your solicitor you are American?

Yes, at the first meeting. They will not advise on American tax, but knowing that it applies changes what they flag to you and what they are willing to negotiate on the timing of payment.

Most employment solicitors will happily talk to your tax adviser.

That conversation costs an hour and regularly saves thousands.

Does a garden leave period change anything?

Not the tax treatment, but it does change the timing. Pay during garden leave is ordinary salary, taxed month by month in both countries, and it falls outside the termination payment rules entirely.

So a long garden leave shifts income into a different tax year.

That can help or hurt depending on your other income.

What if part of the package is a reference or an apology?

Non-financial terms carry no tax on either side of the Atlantic. An agreed reference, an apology or a confidentiality clause adds nothing at all to your income, unless the agreement attaches a specific sum of money to it.

A payment specifically for confidentiality is different, and it is taxable.

Watch how that clause is worded and valued.

Mistakes and penalties we see with a settlement agreement

The first is assuming the settlement agreement split carries across. It protects you in one country only.

The second is signing before anyone models the American number. After signature there is nothing left to arrange.

The third is missing the payment on account. A large sum arriving without withholding creates a charge.

The fourth is losing the breakdown. Without it, the whole payment can end up treated as ordinary earnings.

How US UK Tax Accountants helps

We read the settlement agreement alongside your solicitor, price each element on both sides, and tell you what the package is actually worth after American tax. Then we deal with the payment timing so no charge builds up.

Where you have already signed a settlement agreement, we make sure the return reflects the split properly. Our UK self assessment service covers the British filing.

If you have an offer on the table, get in touch before you sign it. Almost everything useful here happens while the terms are still open.

Last reviewed 30 September 2026. This article is general information and not personal tax advice. Every agreement turns on its own facts, so take advice on yours before signing.