The labor market is constantly evolving and remains under significant pressure. Employers face substantial challenges in recruiting staff, often lacking the luxury of being selective. As a result, positions are increasingly filled by underqualified, overqualified, or otherwise mismatched personnel. Fortunately, in most cases, this does not lead to immediate issues, but sometimes dismissal becomes inevitable. Aside from these trends, many other reasons for terminating an employee's contract exist, such as economic reasons (downsizing, internal reorganization, mergers/demergers, etc.), or the well-known infamous reason: an incident or conflict.

This article is written by Maxim Boschman ([email protected]). Maxim is part of RSM Netherlands International Consulting Services with a focus on Global Employment Services.

At the initiative of the employee, an employment contract can be relatively easily terminated, taking into account the agreed notice period. However, when the initiative comes from the employer, the process is much more complex and subject to the rights and obligations that arise from labor law. In most cases, a termination initiated by the employer results in payments to the employee, such as a transitional or severance payment or a settlement. This article discusses some tax considerations regarding the termination of employment. In future articles, we will continue and delve deeper into specific elements such as settling an employee participation plan, taxation of severance payments in an international context, and pseudo-final levies in special cases.

Severance Pay and Tax Optimization Opportunities

In principle, everything an employee receives from their employment is considered wage and subject to wage taxes. This includes wages earned during current employment and those received based on previous employment. Severance payments fall into the latter category and are thus taxable. They must be paid through the payroll, with the (former) employer withholding and remitting the correct amount of wage taxes.

Under certain conditions, severance payments can be tax optimized. The work-related costs regulation (in Dutch: “WKR”) allows an employer to provide specific allowances and benefits tax-free, even upon or after dismissal. Examples include reimbursing (re)training or education expenses or outplacement costs. For instance, instead of a taxable severance payment of €10,000 gross, the former employer could pay €7,000 gross and additionally cover a €3,000 retraining course. If all conditions are met, wage taxes only need to be withheld and remitted on the €7,000 gross payment.

Another common element is the settlement of unused vacation days. The balance is paid out gross based on the employee's hourly wage. This can be optimized by agreeing with the employee that they will be exempt from work before the employment contract ends, effectively using the remaining vacation days so they do not need to be paid out as taxable wages.

Finally, it is advisable to inventory which company properties the employee has. It can be agreed that they may keep one or more items upon dismissal, but please note that this may be considered as taxable benefit. If the employee may keep company property without paying the fair market value, the amount of the discount is generally considered taxable wages in kind. After all, everything an employee receives in their capacity as an employee is considered wage, subject to wage taxes. Depending on the situation, it can be assessed whether this applies, or if an exemption or exception can be invoked.

Forward thinking

To avoid unexpected surprises, employers should be aware that a dismissal is regulated by labor law, which gives rise to certain rights and obligations. These rights and obligations, as well as other agreements related to the termination of employment, can have tax consequences. Fortunately, wage tax regulations offer opportunities to optimize payments and settlements for tax purposes. However, it is important to address these matters in advance, as there is often little that can be done after the fact.

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