Which labor compensations are taxed in the Personal Income Tax to avoid tax surprises?

The taxation of workers' compensation can be complex, especially for business owners and entrepreneurs who must comply with legal obligations without errors. It is very important to analyze and understand how personal income taxation works for these compensations and what aspects must be taken into account to avoid tax problems.

Workers' compensation and personal income tax: how do they work?

According to article 7 of Law 35/2006 on Personal Income Tax (IRPF), severance pay or termination compensation is exempt from taxation provided that it meets two essential conditions:

• That the amount is established as mandatory in the Workers' Statute or applicable regulations.
• That it does not exceed 180,000 euros , the limit established after the 2014 tax reform.

This exemption is intended to compensate the worker for the loss of his or her job, but it applies only to dismissals regulated by labor legislation, excluding those established by additional contractual agreements or pacts.

Which compensations are taxed?

• Excess over 180,000 euros: If the compensation exceeds this amount, the excess is taxed as employment income.
• Non-mandatory compensation: Compensation that is not included as mandatory minimums in the Workers' Statute, for example, out-of-court settlements that exceed the regulated amounts.
• Payments for voluntary resignation or termination of contract: These are not considered dismissal and, therefore, do not benefit from exemption.

Keys to avoiding tax problems

• Comply with the Workers' Statute: Make sure that compensation strictly complies with the established regulations. For example, for an objective dismissal, 20 days must be paid per year worked with a maximum of 12 monthly payments; in the case of unfair dismissal, compensation will be 33 days per year worked (or 45 days for contracts prior to February 12, 2012).
• Check the exempt amount: Always check that the compensation does not exceed 180,000 euros, since the excess will be taxed.
• Adequate documentation: The company must retain all documentation justifying the dismissal, including signed letters and agreements, to demonstrate that the compensation is legally required.
• Tax advice: Having a specialized advisor is essential to ensure that tax obligations are met correctly and to avoid penalties.

Practical example

If a company dismisses an employee with 30 years' service whose daily salary is 150 euros and who is entitled to compensation of 33 days per year worked, the total compensation would be 148,500 euros (33 days x 30 years x 150 euros). This amount would be completely exempt from taxation as it is below 180,000 euros. However, if the agreed compensation were 200,000 euros, 20,000 euros would be taxed as employment income.

For business owners and entrepreneurs, understanding the tax implications of workers' compensation is crucial to avoid surprises with the Treasury. Complying with the regulations of the Workers' Statute, managing documentation appropriately and being aware of exemption limits are the keys to minimising risks and ensuring tax compliance.