A severance payment is generally subject to income tax, but under certain conditions it may qualify for preferential tax treatment. The timing of the payment, the concentration of income in a single tax year and any other income received in that year are particularly important. An early comparison of different scenarios can help determine which arrangement is most advantageous overall from both a tax and financial perspective.
Not every payment is a severance payment
Not every payment made in connection with the termination of an employment relationship automatically qualifies as a severance payment and therefore benefits from preferential tax treatment.
In particular, the payment must compensate for the loss of future income. Back pay, payments in lieu of holiday, bonuses or remuneration that has already been earned must therefore be assessed separately and may be subject to ordinary taxation.
How is a severance payment taxed?
Where a payment genuinely qualifies as a severance payment, it is generally fully subject to income tax. This is because severance payments usually constitute compensation within the meaning of section 24 of the German Income Tax Act (EStG).
If the requirements of section 34 EStG are also met, the so-called one-fifth rule (Fünftelregelung) may reduce the applicable income tax burden.
The severance payment does not become tax-free. Rather, the rule is intended to mitigate the effect of progressive income tax rates where a large one-off payment is concentrated in a single calendar year.
How is income tax on a severance payment calculated? What does the one-fifth rule do?
For the purposes of the calculation, income tax is first determined without the extraordinary income.
Then, one fifth of the qualifying severance payment is added. The additional amount of tax resulting from this calculation is generally multiplied by five. This determines the tax attributable to the severance payment.
The actual tax benefit depends in particular on the recipient’s other income and personal tax rate. For married couples filing a joint tax return, the income of both spouses also affects how much benefit the one-fifth rule provides. The higher the couple’s remaining taxable income, the smaller the potential relief may be.
It is therefore not possible to give a general figure for the potential tax saving.
Since 2025, the employer generally no longer applies the one-fifth rule when calculating wage tax deductions. Any preferential tax treatment is usually granted only as part of the subsequent income tax assessment.
The amount of tax initially withheld may therefore be significantly higher than the final tax liability.
Please note: For liquidity planning purposes, it is important to bear in mind that the tax relief will generally only arise once the income tax return has been filed and processed. Until any refund is made, the higher wage tax deduction may have a noticeable financial impact.
What are the requirements for the one-fifth rule?
In addition to the payment qualifying as eligible compensation, there must generally be a concentration of income in a single tax year.
Put simply, the compensation must normally be received as a lump sum within one tax assessment period and must result in a higher concentration of income in that year.
Splitting a severance payment across several calendar years is therefore not automatically advantageous. Instalments may prevent the required concentration of income from arising and could therefore jeopardise preferential tax treatment.
Small supplementary payments may be harmless under strict conditions. However, a severance payment should not be divided between different tax years without obtaining tax advice in advance.
Please note: Whether these requirements are met must always be assessed on the basis of the individual circumstances.
What is the receipt principle?
For tax purposes, the receipt principle (Zuflussprinzip) generally applies.
The decisive factor is usually the point at which the recipient is able to exercise economic control over the payment.
If the payment is to be postponed to a different calendar year, the termination agreement, payment due date and actual payment must therefore be coordinated clearly and in good time.
Subsequent changes may have no tax effect or may create additional risks.
How can the timing of the payment be planned effectively?
Whether payment in the current calendar year or the following year is more favourable depends on the individual’s overall income position.
Relevant factors may include
- ongoing salary
- bonuses
- variable remuneration
- rental income
- investment income and
- other one-off payments.
Unemployment benefit, sickness benefit, parental allowance and certain maternity benefits may also increase the applicable tax rate through the German progression clause (Progressionsvorbehalt).
Deductible employment-related expenses, special expenses, pension and insurance contributions and extraordinary expenses may also affect the overall result.
It should also be considered whether the severance payment could affect income-dependent benefits in the relevant calendar year. Where a family is being planned, the income threshold for parental allowance may be particularly relevant.
A reliable decision therefore requires a comparison of several possible payment scenarios. It is not sufficient to look only at the income tax payable in a single year. The overall result should take into account the tax burden, potential social benefits, liquidity and the contractual employment arrangements.
Timing matters when it comes to severance payments
With severance payments, the timing of the payment, other income and the individual circumstances can have a significant effect on the actual tax burden.
If the payment has already been contractually agreed or made, certain planning options may no longer be available.
An early tax review can therefore help compare the available alternatives before a binding decision is made.
ACCONSIS supports you with the tax planning of your severance payment. We assess whether the requirements for the one-fifth rule are met, compare possible payment dates and take into account other income and benefits subject to the progression clause.
Questions about tax planning related to severance payments?
If you have any questions about severance payments and potential tax planning options, I will be happy to assist you.
Simply arrange an appointment using the booking options shown alongside.
Yours sincerely,
Lucas Bürner
Your ACCONSIS contact
Lucas Bürner
Dipl.-Finanzwirt (FH)
Tax consultant
Service phone
+49 89 547143
Email
l.buerner@acconsis.de
FAQ – answers to frequently asked questions about severance payments
Is a severance payment taxable?
Yes. A severance payment is generally fully subject to income tax. Under certain conditions, the one-fifth rule may reduce the applicable tax burden.
Is the one-fifth rule applied directly by the employer?
Since 2025, the one-fifth rule is generally no longer taken into account when wage tax is deducted by the employer. Any tax relief is usually granted only as part of the subsequent income tax assessment.
Is it advisable to split a severance payment across several years?
Not necessarily. Instalment payments can jeopardise the required concentration of income and, as a result, the application of the one-fifth rule.
When is the best time for the severance payment to be made?
That depends on the recipient’s other income, any benefits subject to the progression clause and their personal deductible expenses. A comparison of different payment years can provide clarity.
Image source: ©stock.adobe.com
