Tax Exempt Separation Pay

Q: Are separation benefits to be paid by an employer by reason of the employee’s health condition exempt from income tax and consequently from withholding tax?

A: Yes. Pursuant to Section 32 (B) (6) (b) of the Tax Code, any amount received by an official or employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of death, sickness or other physical disability or for any cause beyond the control of the said official or employee is exempt from taxes regardless of age or length of service. The phrase "for any cause beyond the control of said official or employee" connotes involuntariness on the part of the official or employee. The separation from the service of the official or employee must not be asked for or initiated by him.

This requires the presence of two (2) conditions in order that the employee benefits may be granted tax exemption, namely:

(1) the employee is separated from the service of the employer due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee; and

(2) the employer pays benefits to the official or employee or his heirs as a consequence of such separation.

(BIR Ruling No. 131-10, December 1, 2010)