What to Do When an Employee Leaves - Payroll Terminations Explained

An employee handing in their resignation, or being let go, is one of those moments where payroll can go wrong. Miss an entitlement, get the tax wrong, or forget to notify the ATO and you're looking at Fair Work disputes, ATO penalties or both.

This guide walks through exactly what you need to do when an employee leaves your business, in the right order, so nothing gets missed.

Step 1. Establish the termination date and reason

Before you process anything, confirm two things: the employee's last day of employment and the reason for leaving. The reason matters because it affects what entitlements are owed and how certain payments are taxed.

The main termination types are resignation, redundancy, dismissal and end of contract. Each has different implications for leave payouts and Employment Termination Payments, which are covered below.

Step 2. Calculate what the employee is owed

Final pay in Australia must include everything the employee has earned up to and including their last day. This typically includes:

Wages for hours worked. All ordinary hours, overtime and allowances up to the termination date.

Accrued annual leave. Any unused annual leave must be paid out in full. It cannot be forfeited. Annual leave is paid at the employee's ordinary rate of pay plus leave loading if applicable under their award or agreement.

Annual leave loading. Check the relevant Modern Award. Not all employees are entitled to leave loading on termination, but many are.

Long service leave. Entitlements vary by state and territory and by the reason for termination. In most states, an employee becomes entitled to a payout of long service leave after seven years of continuous service, even if they resign.

Notice period. If the employee is being let go and you choose to pay out their notice rather than have them work it, this amount must be included in the final pay. If an employee resigns and does not work their notice period, the rules around whether you can withhold pay vary, check the relevant award.

What is not paid out. Personal leave (sick leave and carer's leave) is generally not paid out on termination. This is one of the most common questions employers have and the answer in most cases is no.

Step 3. Check whether an Employment Termination Payment applies

An Employment Termination Payment is a lump sum payment made on termination that receives special tax treatment. Not every termination involves an ETP, it depends on what the final pay is made up of.

ETPs typically arise in situations involving genuine redundancy, approved early retirement schemes or certain contractual entitlements. They are taxed differently to ordinary wages and must be reported to the ATO separately through STP.

If you are unsure whether an ETP applies in your situation, speak with your accountant or bookkeeper before processing the pay run. Getting ETP classification wrong has tax consequences for both you and the employee.

Step 4. Process the final pay run in Xero

If you process payroll in Xero, here is the correct process:

Before processing the final pay, approve or reject any outstanding leave requests for the employee. Then ensure any unpaid annual leave is set to paid out and personal leave is set to not paid out. This ensures the correct amounts appear on the final payslip. Process the termination pay run as you would a normal pay run, additional leave payout amounts can be added by setting it as a final pay. Once the pay run is posted, the employee will automatically be terminated in Xero.

Step 5. Lodge with the ATO via STP

Final pay must be paid to the employee by their termination date or within 7 days, and reported via Single Touch Payroll through your payroll software.

In Xero, select the relevant pay run that includes the final pay, and click File. This step is mandatory. Failing to report the termination via STP can result in ATO fines and leaves the employee's record open with the ATO, which causes problems for both parties.

Step 6. Issue the payslip

The employee is legally entitled to a payslip for their final pay. It must be issued within one working day of payment and must clearly itemise every component, wages, annual leave payout, any other entitlements and the tax withheld on each.

Step 7. Process super on the final pay

Super is payable on ordinary time earnings included in the final pay including wages worked and in most cases notice paid in lieu. Super is generally not payable on the unused annual leave payout or redundancy payments, but this depends on the specific components.

With payday super coming on 1 July 2026, super on the final pay will need to be paid at the same time as wages rather than in the following quarter. Factor this into your process now.

The most common mistakes to avoid

• Not paying out annual leave. This is a legal obligation. It cannot be withheld regardless of the circumstances of the termination.

• Getting the tax wrong on unused leave. Unused annual leave paid on termination is taxed differently depending on the reason for termination and how long the employee has been employed. Applying the wrong rate is a common error.

• Missing the 7-day payment window. Delaying final pay beyond 7 days breaches Fair Work rules and can result in a dispute lodged against your business.

• Forgetting to lodge STP. The termination must be reported to the ATO. It does not happen automatically, you need to take the specific steps in your payroll software to notify them.

• Not checking the relevant Modern Award. Entitlements vary significantly across awards. What applies to one employee may not apply to another. Always check before processing.

Employee terminations are one of the most compliance-heavy payroll events a business can face. Done correctly, the process is straightforward. Done incorrectly, it creates Fair Work disputes, ATO attention and stress you don't need.

If you process your own payroll and you are unsure about any step in this process, particularly around ETPs, long service leave or the correct tax treatment of leave payouts, speak with a registered payroll specialist or your accountant before lodging. The cost of getting it right is always less than the cost of getting it wrong.