Tax treatment of severance pay through private agreement

The tax treatment of severance pay received following the termination of an employment relationship is a point of special attention for taxpayers. A recent binding ruling from the Dirección General de Tributos (DGT) has specified the requirements necessary for these amounts not to be taxed under Personal Income Tax (IRPF).

What the DGT has ruled

The DGT has determined that, for severance pay to be considered exempt, the recognition of unfair dismissal must be formally established through one of these two mechanisms:

• An act of conciliation before the Servicio de Mediación, Arbitraje y Conciliación (SMAC).
• A judicial resolution.

If the improved severance pay is produced through a private agreement between the company and the worker, without the intervention of the SMAC or a court, the amount is not exempt. In this scenario, the entire severance pay must be classified as employment income in the tax return.

What this means for you

For the worker, this implies a direct tax burden on the amount received. Since the exemption requirements are not met, the amount is added to their other employment income, which increases the taxable base. However, the regulations allow for partial tax relief: as it is severance pay, the 30% reduction provided for in Article 18.2 of the LIRPF can be applied.

For companies, this criterion underscores the importance of formalizing termination agreements. An agreement that is not channeled through legal conciliation or judicial routes will have different tax consequences for the employee.

What is advisable to do

In a situation of dismissal or contract termination, it is fundamental to evaluate the method of formalizing the agreement. If tax exemption for the severance pay is sought, the recognition of unfair dismissal must appear in the conciliation act or the corresponding judgment. It is necessary to assess each particular situation to determine the tax impact of the chosen option.