Fifth regulation severance pay: this helps to mitigate the tax burden

The Corona crisis is causing unemployment to rise in Germany. When layoffs are imminent, affected employees sometimes receive severance pay. But the tax authorities also have a hand in the process. How employees can save taxes on severance pay.

Golden handshake with pitfalls: Severance payments are subject to a tax burden. – © Anthony Leopold –

  • Severance pay: The most important questions and answers
  • Insolvency: Do employees have to forego salary??

The Corona pandemic has hit the labor market with full force. Millions of workers are on reduced hours, while others have already lost their jobs: In May 2020, the Unemployment rate in Germany at 6.1 percent, the number of people registered as unemployed rose by more than 169 compared to the previous month.000 an. Compared with May last yearly the number of the unemployed ones rose even around 577.000 to. And experts are convinced that further job cuts will follow.

Losing one’s job through dismissal is a bitter pill to swallow. Some employees receive a severance payment. But one There is no fundamental entitlement to it: "In principle, employees have no legal entitlement to severance pay in the event of termination", says Johannes Schipp, specialist lawyer for industrial law from Gutersloh. Nevertheless, it can Under certain conditions, those affected may be entitled to severance pay. This is the case, for example, if a social compensation plan has been negotiated with the works council or if it is included in a collective agreement. Sometimes employers offer severance pay on their own initiative in order to avoid a lengthy dispute before the labor court. This is because employers run the risk, especially in the case of protracted proceedings, of having to pay the employee’s wages for the period in which he or she did not work as a result of the dismissal if the case is won.

Severance pay: The tax office holds out its hand

Sometimes dismissed employees are also awarded a severance payment in the context of an action for protection against dismissal. One constellation in which employees receive a severance payment is, for example, if the works council is not involved: In this case, the employee can claim compensation for disadvantages under the Works Constitution Act. In general, the following applies, according to Schipp: "The more incorrect the dismissal, the higher the severance pay." Courts often use a rule of thumb of half a gross month’s salary per year of employment to get negotiations between the parties started. Compellingly this rule of thumb is however not.

In principle, severance pay is regarded as a one-time cash payment by the employer to the employee. It is intended to compensate the employee for the loss of the job. But even if the severance sums sometimes sound princely, little could be left of them in the end. The tax office has a firm hand on severance payments: "Severance payments due to dismissal from an employment relationship are in principle liable to wage tax in the full amount", Says Andreas Baumann, managing partner of the Wurzburg-based tax consulting firm Dr. Kley. And not only that: "Given the progressive course of the tax rate in Germany, a high severance payment has a major impact on the tax rate, since the severance payment greatly increases taxable income and thus the tax burden." At least: social contributions do not have to be paid for the severance pay.

Fifths rule: severance pay is fictitiously distributed over five years

The so-called quintuple rule helps the employees concerned to reduce the tax burden at least somewhat. Under this procedure, which is regulated by the Income Tax Act, the severance payment is fictitiously distributed over five years. "Severance pay can be taxed using the one-fifth rule if it is extraordinary income", explains tax advisor Baumann. "These conditions are met if the severance payment is made within a calendar year and an increased tax burden can result from the so-called ‘accumulation of income’." Under the one-fifth rule, the tax on the severance pay is five times the difference between the tax on ordinary income and the tax on ordinary income plus one-fifth of the severance pay. This reduces the burden somewhat, but the tax must still be paid in one go.

Tax advisor Baumann illustrates the extent to which the one-fifth rule reduces the tax burden by means of an example calculation example: A married couple comes to a joint gross salary of 60.000 Euro (per spouse 30.000 euros). After deducting income-related expenses and pension costs, this results in a taxable income of around 48,000 euros.500 euros – and an income tax in the splitting tariff of approx. 7.500 euros. If one of the spouses receives a severance payment of 100 euros in the same year, the other spouse will receive the same amount.000 euros, the tax burden would be reduced to around 47.500 Euro would accrue. In real terms, of the 100.000 euros severance pay only 60.000 euros left over.

Great effect for low incomes

The one-fifth rule alleviates the tax burden somewhat: In the first step, the tax authorities calculate the tax for the income without severance pay, then the income is fictitiously increased by one-fifth of the severance pay. Of the tax calculated from this, the 7.500 euros are deducted, which would have to be paid anyway, resulting in the so-called differential amount. This in turn is quintupled and added to the tax without severance pay. At the end there is the tax to be paid – in the example case it would be ca. 39.500 euros. In real terms, of the 100.000 Euro settlement there would still be about 68.000 euros left over.

"The effect of the one-fifth rule is all the greater, the smaller the normal income", explains tax consultant Baumann. "For this reason, in the case of dismissals, for example, at 31. December of a year it is to be paid attention that the compensation is not still paid in the current year, for which still normal wage was referred, but only at the beginning of the next year, in which then due to unemployment or longer job search for several months no wage at all is referred." In the example case then only 27.000 euros in taxes are incurred – and thus of the severance pay 81.000 Euro from the 100.000 euros of severance pay left over.

Save taxes by paying into a pension fund

Another way to save taxes is the Payment of severance pay into a direct insurance policy, pension fund or a pension fund. The maximum amount of the tax-free payment is four percent of the current contribution assessment ceiling for pension insurance, multiplied by the number of years the employment relationship existed (maximum ten years). "The application does not require that the employment relationship was terminated by the employer", says Baumann. "It is also possible if the employee leaves voluntarily or because of reaching the age limit."

Employees who have been bullied in their company can save instead of severance pay tax-free compensation for pain and suffering receive. Thomas Schulze, management consultant and financial coach from Hoym in Saxony-Anhalt points this out. This is regulated by the Equal Treatment Act. Such compensation payments are tax-free because they are compensation for non-material damage caused by the employer due to the bullying. "Important: Discrimination must be proven." Otherwise, this is a so-called circumvention case – and the employee is liable to prosecution for tax evasion, and the company is liable to prosecution for fraud.

They use a free offer of the German handicraft newspaper. The information provided here has been researched and compiled with the utmost care. However, it does not replace professional advice. Please note that this may also be information from our archives that has become outdated in the course of time. The topicality of an article is always displayed above the headline on our website.

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