When an employee's employment contract is terminated sooner than their notice period, and they are paid the amount of notice period that hasn't been worked as additional income in their final pay, this is known as Pay In Lieu Of Notice (PILON).
PILON is taxed as regular income, unlike severance payments. This means that the employee will be taxed on the amount of PILON they receive, just as they would be taxed on their regular salary.
If you choose to substitute a worked notice with PILON, the employee's final working day will be brought forward. This means that you will need to manually add the additional income to their final pay.
How to work out PILON:
When you offboard someone you'll get given the option to add PILON as part of the Leaver flow. This will automatically calculate the leaver's day rate and pro-rated time left on registered time-off policies. We'll show you the calculation, if you're happy with it you'll get the option to add that to the relevant month's payroll.
If you want to calculate it manually you can follow the steps below:
Calculate the number of days (or months) the employee would have worked, should they have worked their entire notice
Multiply this number by their daily rate (for days) or monthly salary (for months).
Add this amount to the leaver's final pay, as a bonus in payroll.