Introduction: Garden Leave Pay and the Cross-Border Sourcing Problem
Garden leave pay is taxed according to where you would have worked during your notice period, not where you happen to be sitting while the money lands. That single sentence resolves most of the confusion American executives face when they resign from a London bank, a private equity house or a hedge fund and are told to stay away from the desk for six months. Furthermore, it explains why a US citizen who flies home to New York in week three of a six-month notice period still faces a full UK tax charge on every pound of that garden leave pay.
The stakes are substantial. A managing director on £450,000 with a six-month notice period is looking at £225,000 of garden leave pay flowing through a UK payroll while their tax residence, their physical presence and often their next employer sit on the other side of the Atlantic. Consequently, two revenue authorities each have a plausible claim, two tax years overlap awkwardly, and the foreign tax credit that should neutralise the overlap can fail on a technicality.
At TaxYork we handle this scenario constantly for senior finance professionals leaving the City. Notably, the mistakes we see are rarely about the UK payroll, which usually operates correctly. Instead, they sit on the US return, where garden leave pay gets sourced to the wrong country, the exclusion gets claimed when it is unavailable, and the credit gets stranded in the wrong basket. This guide fixes all three.
What Garden Leave Pay Actually Is in UK Law
Garden leave pay is ordinary salary for a notice period during which your employer requires you to stay away from the workplace. Critically, you remain an employee throughout. Your contract continues, your benefits continue, your restrictive covenants continue, and your employer keeps you off the market and away from clients.
Because the employment relationship survives, garden leave pay is general earnings under the employment income rules. Therefore, it attracts PAYE and National Insurance in exactly the same way as your normal monthly salary. It is emphatically not a termination payment, and the distinction drives everything that follows.
Garden leave sits inside the statutory and contractual framework described in the Acas guidance on notice periods, and it operates as an alternative to a payment in lieu of notice. However, the tax consequences diverge sharply, and that divergence is where most cross-border planning either succeeds or fails.
Why Americans Face a Problem Nobody Else Faces
A British colleague on garden leave has a simple tax life. They pay UK tax through PAYE, the employer gets the withholding right, and the matter closes. Meanwhile, an American in the same seat carries a second filing obligation that never switches off.
The United States taxes its citizens on worldwide income regardless of residence. Accordingly, your garden leave pay must appear on a Form 1040 even though a UK employer paid it, a UK payroll taxed it and you never set foot in the United States while earning it. The Internal Revenue Service explains the reach of this rule in its guidance on international individual tax matters.
How HMRC Sources Garden Leave Pay for a Departing Executive
HMRC sources garden leave pay to the location where you would reasonably have performed your duties during the notice period. Consequently, a London-based managing director generates UK-source earnings for the whole notice period, even after relocating abroad partway through.
The Notice Period Test, Not the Physical Presence Test
The principle comes from the employment income article of the tax treaty network and the accompanying OECD Commentary. Specifically, remuneration paid in respect of a period of notice is treated as derived from the state where the employee would have worked had the notice been served in the usual way.
The underlying charge sits in section 62 of the Income Tax (Earnings and Pensions) Act 2003, which defines earnings from an employment. Accordingly, contractual elements such as garden leave and payments in lieu of notice are sourced over the notice period in the employee's expected work location. As a result, physically decamping to Connecticut on day one changes nothing about the UK charge on your garden leave pay.
This surprises people. However, the logic is sound. Your employer is paying you to remain contractually bound to a London role and to stay out of the London market. Therefore, the payment relates to that role.
Where the Rule Bends: Genuinely Split Duties
The rule does bend where your duties were genuinely split before you resigned. For instance, an executive who spent forty per cent of their working time in the United States for the three years before termination has a credible argument that forty per cent of the garden leave pay is US-source.
HMRC's own manuals on non-resident employment income set out how the employment article applies to duties performed inside and outside the United Kingdom. Furthermore, the apportionment must be evidenced. Diaries, travel records and payroll workday data all matter, and HMRC will ask for them.
PAYE Notifications and the New 30% Cap
Employers of internationally mobile staff can notify HMRC that part of a payment should sit outside PAYE. Previously this required a formal direction under section 690 of the Income Tax (Earnings and Pensions) Act 2003. However, from 6 April 2025 the direction process gave way to a simpler employer notification, described in HMRC's PAYE manual guidance on globally mobile employees.
A further change bites now. Specifically, from 6 April 2026 the notification is capped so that the employer's estimate of qualifying employment income cannot exceed thirty per cent where Overseas Workday Relief applies. Consequently, senior employees with substantial non-UK workdays may see more of their garden leave pay withheld at source than the eventual liability requires, with the balance recovered through Self Assessment.
The US Side: Sourcing, the Exclusion and Garden Leave Pay
American filers must answer a separate question that HMRC never asks. Specifically, is the garden leave pay foreign-source or US-source for United States purposes, and does any of it qualify for the foreign earned income exclusion?
Time-Basis Sourcing Under the Regulations
United States sourcing of compensation follows where the services were performed. Where services span both countries, the regulations apportion on a time basis. The relevant rule sits at Treasury Regulation section 1.861-4, and the IRS summarises it in its guidance on the source of personal service income.
Garden leave creates an obvious difficulty. After all, no services are performed at all. Therefore, the better view treats garden leave pay as compensation for the notice period attached to the underlying employment, sourced to the country where those duties would have been carried out. That view aligns the US answer with the UK answer, which is exactly what you want.
Nevertheless, an aggressive examiner could argue that pay received while you sit in Manhattan is US-source. Consequently, the position should be documented before the return is filed rather than defended afterwards.
The Foreign Earned Income Exclusion Trap
For 2026 the maximum foreign earned income exclusion is $132,900, up from $130,000 for 2025, as confirmed in the IRS announcement of tax year 2026 inflation adjustments. Many executives assume the exclusion will absorb a chunk of their garden leave pay. Frequently, it will not.
Two conditions defeat the claim. Firstly, the exclusion requires a tax home outside the United States. Therefore, the moment you repatriate and establish a US tax home, subsequent garden leave pay stops qualifying, even though the UK continues to tax it. Secondly, the statute excludes amounts received after the close of the tax year following the year in which the services were performed.
The IRS sets out both tests in its guidance on what counts as foreign earned income. Importantly, for a high earner the exclusion is a rounding error anyway. At £450,000 of salary the exclusion is exhausted long before the notice period begins, so the foreign tax credit does the real work.
Why the Credit Matters More Than the Exclusion
The foreign tax credit converts UK tax paid into a dollar-for-dollar reduction of US tax on the same income. However, the credit only works if the income is foreign-source in American eyes. Therefore, sourcing is not an academic question. It decides whether you pay tax once or twice on the same garden leave pay.
Where the two systems disagree, the treaty supplies the fix. Furthermore, that fix requires paperwork that most preparers omit, as the next section explains.
The Treaty: Article 14 and Which Country Wins
Article 14 of the US-UK income tax treaty governs employment income. Broadly, it gives primary taxing rights to the country where the employment is exercised, subject to a short-stay exception for visits under 183 days in any twelve-month period.
Applying Article 14 to a Notice Period
Because garden leave pay relates to duties that would have been exercised in the United Kingdom, Article 14 hands primary taxing rights to HMRC. Consequently, the UK charge stands, and the United States must give relief rather than the other way round.
The savings clause complicates this. Specifically, the treaty preserves the right of the United States to tax its own citizens as if the treaty did not exist. Therefore, an American cannot simply cite Article 14 and exempt the income from US tax. Instead, relief flows through the credit mechanism in Article 24.
The Chartered Institute of Taxation maintains useful background on treaty interpretation in its tax guidance library, and the OECD publishes the model on which the article is based through its tax treaties resource centre.
The Re-Sourcing Rule Almost Nobody Files
Article 24 contains a re-sourcing provision. In short, where the United Kingdom taxes income that the United States would otherwise treat as US-source, the treaty re-characterises that income as foreign-source so the credit can operate. This is the rescue mechanism for garden leave pay received while physically in the United States.
Two filing steps follow. Firstly, you disclose the treaty position on Form 8833. Secondly, and this is the step routinely missed, treaty re-sourced income needs its own Form 1116, separate from your general limitation basket. Combining them invalidates the calculation and typically produces an excess credit that never gets used.
Timing the Credit Against a Mismatched Tax Year
The UK tax year ends on 5 April while the US year ends on 31 December. Accordingly, a six-month garden leave period straddling April splits across two UK years and lands in one or two US years depending on payment dates.
On the cash basis, the credit arises when the UK tax is paid. Therefore, an executive who settles a large Self Assessment balance in January can find that two UK years of tax bunch into a single US calendar year, wasting credit. The accrual election under section 905(a) fixes the mismatch, though it binds you permanently once made.
Garden Leave Pay Versus PILON and Post-Employment Notice Pay
Confusing garden leave pay with a payment in lieu of notice produces expensive errors. The two are taxed under different regimes, and only one interacts with the post-employment notice pay rules.
The £30,000 Exemption Does Not Apply
The £30,000 exemption for termination payments covers relevant termination awards and statutory redundancy pay. However, garden leave pay is contractual salary, not a termination award. Consequently, none of it shelters under the exemption, and none of it escapes National Insurance.
HMRC's guidance on relevant termination awards received on or after 6 April 2018 draws the boundary. Where an employee serves the full notice period on garden leave, the post-employment notice pay rules simply do not apply. In contrast, a PILON is treated as earnings in full and feeds directly into the post-employment notice pay calculation.
How PENP Interacts With International Duties
Where garden leave covers only part of the notice period, post-employment notice pay can still arise on the balance. HMRC addresses the international dimension in EIM13899 on the PENP formula for internationally mobile employees, updated on 12 August 2026.
The manual makes two points that matter. Firstly, all workdays and earnings enter the calculation regardless of whether the duties were performed overseas. Secondly, the full contractual PILON goes into the deduction even where part of it falls outside the UK charge. As a result, the formula can produce a PENP figure that looks disconnected from the taxable amount.
Structuring the Exit Deliberately
Because the regimes differ, the choice between garden leave and a PILON should be a deliberate one. Furthermore, for an American the calculus differs from a British colleague's, since only the American faces a second tax system and a credit-timing problem.
Longer garden leave keeps you employed, keeps National Insurance running and keeps the income firmly UK-source. Conversely, a clean PILON accelerates the payment into a single tax year and may suit a repatriating executive better. We model both routes as part of our cross-border planning work before the settlement agreement gets signed.
National Insurance and Social Security on Garden Leave Pay
National Insurance continues on garden leave pay exactly as it does on ordinary salary, because you remain an employee throughout the notice period.
The 2026/27 Rates That Apply
For 2026 to 2027 the employee main rate is 8% on earnings between the primary threshold of £12,570 and the upper earnings limit of £50,270. Above that limit the rate drops to 2%. Employers pay 15% above a secondary threshold of £5,000. HMRC publishes the complete table in its guidance on rates and thresholds for employers 2026 to 2027.
For a managing director, therefore, the marginal National Insurance cost on garden leave pay is 2% for the employee and 15% for the employer. Meanwhile, income tax runs at 45% above £125,140, since the personal allowance has already tapered to nil.
Totalisation and the Certificate of Coverage
American executives frequently ask whether US social security taxes also apply. Generally, they do not, because the US-UK totalisation agreement prevents double social security charges on the same earnings. The Social Security Administration explains the mechanism in its overview of the agreement with the United Kingdom.
Nevertheless, a certificate of coverage must exist and must cover the relevant period. Consequently, an executive whose certificate expires mid-notice can find a self-employment or FICA exposure appearing where none was expected.
Repatriation Mid-Notice
Where you return to the United States and start on a US payroll only after garden leave ends, National Insurance normally continues on the UK employment until the contract terminates. However, the analysis changes if the UK employment ends earlier and the payment becomes a termination sum. Therefore, the contractual end date deserves as much attention as the payment date.
The Residence Traps Hidden Inside Garden Leave
Garden leave quietly wrecks residence planning, and this is the point competitors miss entirely. The problem is that you remain employed by a UK employer while doing no work anywhere.
Split-Year Treatment Can Fail
The Statutory Residence Test offers split-year treatment to individuals leaving the United Kingdom, most commonly where they start full-time work overseas. However, an executive on garden leave has not started full-time work overseas. Instead, they remain contractually employed in Britain and are prohibited from working elsewhere.
Consequently, the case that would normally split the year may be unavailable until the notice period expires. As a result, an executive who leaves London in December can remain UK resident for the whole tax year, exposing worldwide income including any US investment gains realised after departure.
Day Counting Still Runs
Days spent in the United Kingdom during garden leave count towards the Statutory Residence Test in the ordinary way. Furthermore, ties such as accommodation, family and the ninety-day test continue to apply. Therefore, an executive who keeps a London flat through a six-month notice period accumulates ties even while planning to leave.
The US Presence Tests Move Too
On the American side, repatriating mid-notice can break bona fide residence for the year. However, days abroad still count for the physical presence test, and a taxpayer who has spent 330 qualifying days abroad in a rolling twelve-month period may still claim relief for part of the year. Both routes are explained in the IRS overview of the foreign earned income exclusion.
A Worked Case Study: Six Months of Garden Leave Pay
Consider Alex, a US citizen and long-term London resident, working as a managing director at an investment bank on a base salary of £450,000. Alex resigns on 31 October 2026 with a six-month notice period and is placed on garden leave from 1 November 2026 until 30 April 2027. Alex relocates to New York on 1 December 2026 and starts a new US role on 1 May 2027.
The UK Position
Alex's garden leave pay totals £225,000 across the six months. HMRC treats all of it as UK-source, because Alex would have worked in London throughout the notice period. Therefore, the London payroll continues to operate PAYE on the full amount.
The payments split across two UK tax years. Specifically, £193,750 falls into 2026/27 and £31,250 falls into 2027/28. Income tax on the 2026/27 slice runs at 45%, producing £87,188, with employee National Insurance at 2% adding £3,875. Consequently, the UK cost on that slice reaches £91,063.
The US Position and Where It Goes Wrong
Alex's US return for calendar year 2026 must include the November and December garden leave pay of £75,000, worth roughly $98,250 at an assumed rate of £1 to $1.31. The exclusion is already exhausted by Alex's January to October salary, so the foreign tax credit must carry the load.
November presents no difficulty. Alex had a UK tax home and the income is plainly foreign-source. December is the problem. Alex now has a US tax home and physically sits in Manhattan, so an examiner could treat that $49,125 as US-source. In that event, the UK tax of roughly $23,088 on the December slice becomes non-creditable, and Alex pays US tax of about $18,176 on income already taxed at 45% in Britain.
The Fix, Applied Before Filing
We resolve this by claiming the treaty re-sourcing rule. Accordingly, Alex files Form 8833 to disclose the position and prepares a separate Form 1116 for treaty re-sourced income alongside the general limitation basket. As a result, the December UK tax becomes fully creditable and the double charge disappears.
One further step protects the 2027 position. Because the April 2027 garden leave pay falls into the UK 2027/28 year but a 2027 US calendar year, Alex reviews whether the section 905(a) accrual election aligns the two. In Alex's case the election saves a further $9,400 of otherwise wasted credit.
Reporting Obligations Triggered by Garden Leave Pay
A large notice-period payment landing in a UK bank account creates reporting consequences that catch people out well after the money has been spent.
FBAR and Form 8938
Six months of garden leave pay hitting a UK current account will push the balance far past the $10,000 aggregate threshold for the Report of Foreign Bank and Financial Accounts. Furthermore, the threshold is measured on the highest balance at any point in the year, so spending the money later provides no protection.
Form 8938 sits alongside the FBAR with higher thresholds and different rules. Our FBAR and FATCA reporting service handles both, and the practical guidance published by MoneyHelper on managing money across borders is a useful starting point for the banking side.
UK Self Assessment After You Leave
Leaving the United Kingdom does not end your Self Assessment obligations. Notably, a final return covering the departure year is usually required, and the PAYE operated on garden leave pay after your P45 has been issued is frequently wrong. Employers must apply a 0T code on a week one or month one basis to post-P45 payments, which commonly over-withholds.
Therefore, reclaiming the excess through the return matters. Additionally, where a section 690 notification has restricted withholding, an underpayment can arise instead.
If You Have Already Missed Filings
Many executives discover mid-exit that earlier years were never filed correctly. In our experience, the trigger is often a mortgage application in the United States that requires three years of tax returns. Consequently, an otherwise routine departure becomes a compliance exercise.
The IRS operates the Streamlined Filing Compliance Procedures for taxpayers whose failures were non-wilful. Our IRS Streamlined Filing service prepares the three years of returns, six years of FBARs and the non-wilfulness certification that the programme demands. Meanwhile, our US tax return preparation for expats covers the current year alongside it.
How TaxYork Can Help With Garden Leave Pay
We prepare US and UK returns for senior finance professionals leaving the City, and we do it before the settlement agreement is signed wherever possible.
What We Do Before You Sign
Firstly, we model the tax outcome of garden leave against a payment in lieu of notice across both systems. Secondly, we identify the sourcing position on your garden leave pay and document it contemporaneously. Thirdly, we test whether split-year treatment survives your notice period.
What We Do at Filing
We prepare the US return with the correct Form 1116 baskets, the Form 8833 treaty disclosure where re-sourcing applies, and the FBAR and Form 8938 filings the payment triggers. Furthermore, we prepare the UK Self Assessment return that recovers over-withheld PAYE on post-P45 amounts.
Who We Act For
Our clients are investment bankers, private equity and hedge fund principals, technology founders and senior executives with substantial cross-border compensation. Accordingly, our work assumes complexity rather than treating it as an exception. Professional standards guidance from the ICAEW underpins how we document every position we take.
Conclusion
Garden leave pay belongs to the country where you would have worked, and for a departing London executive that country is almost always the United Kingdom. Therefore, the UK charge is the starting point rather than something to be argued away.
The American problem is never the UK tax itself. Instead, it is the risk that the United States sources part of the same garden leave pay domestically, denies the credit and taxes it a second time. Fortunately, the treaty re-sourcing rule solves this, provided you file Form 8833 and a dedicated Form 1116 rather than folding everything into one basket.
Ultimately, garden leave is a planning window, not a dead period. Use it to fix historic filings, to time your residence change deliberately and to align two tax years that were never designed to fit together.
Contact Us
Speak to a specialist before you sign your settlement agreement rather than after. To review your notice period, your sourcing position and your filing history, contact us or book a consultation with our cross-border team.
Email hello@taxyork.com or call 020 3488 8606. We act for high-net-worth Americans in Britain and British nationals with US exposure, and we handle both sides of the return in one place.
Disclaimer
This article provides general information about garden leave pay and cross-border taxation. It does not constitute tax advice and should not be relied upon in place of professional guidance tailored to your circumstances. Tax rules change, and figures cited reflect published rates for the 2026 and 2026/27 tax years at the date of writing. Always obtain specific advice before acting.
Written by the TaxYork Expert Team — US-UK tax specialists.