Taxation of Lump Sum Payments in Kenya
Formal employment often ends with a final paycheck that includes more than your regular salary. This one-time payment, known as a lump sum, might include gratuity, severance pay, bonuses, notice pay, or leave pay. While welcome, these payments are taxable, and both employees and employers must understand how taxation of lump sum payments is handled under Kenyan law.
What is a Lump Sum Payment?
A lump sum payment is a one-time, large payout made to an employee upon retirement, termination of contract, or completion of service. It may consist of:
- Gratuity or severance pay
- Payment in lieu of notice
- Accrued leave pay
- Bonuses or commissions
Tax Responsibility
Employers must deduct and remit tax on lump sum amounts before disbursing the balance to the employee. Even if the payment is made in a year different from when it was earned, it is taxed in the year it was earned.
How to Calculate Tax on Lump Sum Payments
- Add the lump sum to total taxable income of the relevant year.
- Apply the annual PAYE tax bands to the revised total income.
- Deduct personal relief and any PAYE already paid for that year.
- The resulting balance is the tax due on the lump sum.
Treatment of Different Lump Sum Components
- Notice Pay: Taxed in the year it is received.
- Leave Pay: Taxed in the year it was earned.
- Gratuity for fixed-term contracts: Spread evenly over the unexpired contract period.
- Gratuity for unspecified contracts: Taxed based on annual gross pay prior to termination.
- Unspecified terminal payments: Spread evenly over three years post-termination.
Example Breakdown: Mr. Peter Bakari
Mr. Bakari left employment in September 2016 and received:
- KShs 660,000 service gratuity (for 30 years)
- KShs 90,000 notice pay (3 months)
- KShs 25,000 leave pay (2015)
Gratuity is spread backward over five years:
| Year | Taxable Amount (KShs) |
|---|---|
| 2016 | Notice Pay – 90,000 |
| 2015 | Gratuity – 22,000 + Leave Pay – 25,000 = 47,000 |
| 2014 | Gratuity – 22,000 |
| 2013 | Gratuity – 22,000 |
| 2012 | Gratuity – 22,000 |
| 2011 | Gratuity – 22,000 + Remaining 550,000 for 2010 & earlier |
The amounts are combined with income earned in those years and taxed accordingly.
Final Notes
The taxation of lump sum payments applies to all employees, including full-time service directors. To comply with the law, employers must:
- Deduct applicable taxes at source
- Spread gratuity payments appropriately
- Use relevant tax rates for each portion
Employees should ensure that proper documentation is maintained, and calculations verified to avoid tax surprises in their final employment year.
