Understanding Vacation Payout Taxes in Israel: A Detailed Guide
Israeli employees often face confusion regarding the taxation of their unused vacation days when they leave a job. While the gross amount of 34 accumulated vacation days can be worth NIS 21,966, the net amount received and the actual tax owed can differ significantly from what is initially deducted.
The primary issue lies in how taxes are calculated. Employers typically deduct taxes based on a monthly bracket system, which can lead to over-deduction when a lump sum payout is added to the final month's salary. For an employee earning NIS 14,000 monthly and working five days a week, the tax deducted on the vacation payout in the final payslip might be 30.5%, totaling NIS 6,694. However, income tax is assessed annually.
If the employee's total annual income, including the vacation payout, does not push them into a higher tax bracket, the actual tax owed on the payout could be lower. For instance, an employee earning NIS 14,000 consistently throughout the year would have their total income, including the NIS 21,966 payout, fall within the 20% tax bracket. This results in an actual tax of NIS 4,393 on the payout, meaning NIS 2,301 was over-deducted and can be reclaimed through a tax refund.
Employees who leave their jobs mid-year are often in a better position, as their total annual income is lower, placing more of the vacation payout into lower tax brackets. For example, someone leaving at the end of June might only owe around NIS 3,070 in tax on their payout, having had NIS 6,694 deducted initially, leading to a substantial refund.
There is also a provision, under section 8(c)(2) of the Income Tax Ordinance, allowing employees to spread their vacation payout retroactively over the years the days were accrued, up to six years. This can further reduce the tax burden, especially for those with unusually high income in their final year of employment. Importantly, vacation payout is exempt from National Insurance and Health Insurance contributions, unlike utilized vacation days which are treated as regular salary with full contributions. Employees should retain their Form 106 from their year of departure to document deductions and claim any overpaid taxes.
