Severance pay

Severance pay is an extraordinary payment that can be paid once by the employer to the employee upon termination of the employment contract. This is intended to compensate the employee for the loss of his or her job as well as for the lost wages. Legal claims to severance pay arise only from certain causes of termination. Since one does not assign the severance pay to the employment relationship or the remuneration but to the dismissal compensation, one does not deduct any social security contributions from it.

Who is entitled to a severance payment?

In Germany, employees do not generally have a legal claim to severance pay when their employment relationship is terminated. Thus, he is not automatically entitled to a severance payment in the event of a termination.

However, this can be regulated in collective agreements, social plans, management contracts or individual employment contracts. Voluntarily agreed severance payments in termination agreements or settlement agreements are also possible. If employers generally provide severance pay in the event of a termination, other employees may be entitled to the payment as a result of a company practice.

A claim to severance pay can also arise in the event of termination for operational reasons if the employer offers severance pay with a reference to § 1a of the Protection against Dismissal Act (KSchG) in the letter of termination.

In the event of an action for protection against dismissal, which is initiated by the employee, the employer may decide to make a voluntary payment. In this way, the employer avoids the risk of losing the case in court and suffering financial losses that are even higher than the agreed severance payment.

In the case of a termination that was not legally declared, the court can order the employer to pay a severance payment. In such a case, it is assumed that the invalidly terminated employee cannot reasonably be expected to continue the employment relationship, and the employment relationship is dissolved by court order.

severance pay in the termination agreement

Employer and employee can agree on a severance payment in a termination agreement in which the dissolution of the existing employment relationship is regulated. This is intended to compensate the employee for losing his or her job and thereby losing wages. Often the construction of a termination agreement plus severance pay is used when the termination is initiated by the employer. Thus, in the event of a supposedly effective termination, the employee escapes the risk that the stated reason for termination will not be sufficiently valid in court. If, on the other hand, the request for a termination agreement comes from the employee because, for example, he wants to start a new job as quickly as possible, there is no reason for the employer to agree on a severance payment.

Severance pay in the event of termination for operational reasons

If the employer gives notice of termination for operational reasons, the employee may be entitled to severance pay as a result. The following requirements must be met:

The Dismissal Protection Act (KSchG) must take effect

In order for the Dismissal Protection Act to apply to the employment relationship, it must have existed for at least six months without interruptions. In addition, it is necessary that the company employs at least ten employees full-time (§ 23 (1) KSchG). Accordingly, the Dismissal Protection Act does not apply in smaller companies.

Urgent operational requirements must be present

In order for the termination to take effect, it must be based on urgent operational requirements according to § 1 (2) no. 1 KSchG can be attributed to. These can be, for example, a permanent decline in the order situation (BAG, judgment of 23. February 2012, Az. 2 AZR 548/10) or operational restructuring. The employer must be able to prove that he cannot deploy his employee elsewhere in the company. The letter of termination from the employer must contain the reason of the operational requirements.

Offer of severance pay in exchange for waiver of action must be made

Within the scope of the termination declaration, the employer can offer a severance payment in accordance with § 1a KSchG. In return, the dismissed employee must refrain from filing an action for protection against dismissal before the labor court within three weeks and allow the period for filing an action to expire (Sec. 4 KSchG).

Severance pay must be claimed

After the dismissed person refrains from filing an action for protection against dismissal and allows the deadline for filing such an action to expire, he is entitled to claim his severance pay. The calculation of this is regulated by law: One multiplies the half gross monthly salary of the employee with the years of employment in the company. After six months, the length of service is rounded up to a full year (§ 1a (2) KSchG).

Calculation example for severance pay

Kristin was terminated for operational reasons after 6 years with her company. In the notice of termination, the boss offers her severance pay if she does not file an action for protection against unfair dismissal. As she lets the three-week time limit for filing suit expire, she is now entitled to a severance payment. Your gross monthly salary was 3.500 euros. Accordingly, she is now entitled to a severance payment of 10.500 euros.

3.500 Euro gross salary / 2 = 1.750 euros

1.750 euros * 6 years of service = 10.500 euros severance pay

Is it allowed to terminate an employee because of working time fraud? Read in our advice article what you need to consider in such a case! Learn more in Working time fraud: Deception in time recording costs job.

Severance pay under the Dismissal Protection Act

If the dismissed employee decides to exercise his or her right to take legal action against the dismissal, he or she could be entitled to severance pay. If the court determines in the course of the proceedings that the termination was invalid, but the employee cannot be expected to continue the employment relationship, the court will determine a severance payment (Section 9 KSchG). This is how the court finally dissolves the employment relationship.

According to § 10 (2) KSchG, the amount of severance pay is calculated as follows:

Under-50s receive up to twelve months’ pay. Over 50, there is up to 15 months’ salary. If the dismissed person is over 55 years old, a maximum of 18 months’ salary is possible. For this, the employee must have worked for the company for 20 years and must be below the age of the standard retirement age. The salary also includes benefits in kind.

Severance pay by settlement

The labor court, before which the dismissal protection lawsuit is being fought, suggests a settlement for the two parties on its own initiative. This type of agreement is particularly advantageous for the employer. In this way, the employer avoids the risk of having to continue to pay the employee’s wages if the termination is declared invalid. Therefore, in a court or out-of-court settlement, the employer promises a severance payment in return for the employee accepting the validity of the dismissal. The amount of the severance payment is a matter of negotiation in this case.

Severance pay in collective agreement and social plan

Severance pay can also be regulated in a collective bargaining agreement or a works agreement. This entitlement applies accordingly to all employees who fall under the scope of the company agreement or collective agreement.

For dismissals in the case of major operational changes, a social plan is required. In such a plan, which the employer and the works council have agreed upon, a severance payment may also be stipulated, which gives rise to a claim to it. The amount or the calculation of the severance pay is not fixed in this case. The decisive factor is the social interests of the departing employee. Likewise, the length of service, salary and age are also taken into account. The employer should observe the principle of equal treatment, which also applies to severance pay and prevents major discrepancies between comparable benefits.

Severance pay as compensation for disadvantages

Employers enter into a reconciliation of interests with the works council in which they agree on the change in operations. If the employer deviates from this without a compelling reason, this change is not legal. Affected employees then often sue for compensation before the labor court. The court then determines a severance payment for the employee.

This also applies to cases in which the employer does not even attempt a reconciliation of interests with the works council. In the event of dismissal or other economic disadvantages for employees, a claim for severance pay may also arise in this way. Here, too, the amount of the severance payment is calculated in accordance with § 10 KSchG (see above).

How severance pay is calculated?

If there is no legal entitlement for the severance pay and therefore no regulation for the calculation, the so-called "rule of thumb" is used. This states that approximately one Half to full gross monthly salary per year of employment for a severance payment is appropriate. Most labor courts use this rule of thumb to determine an amount. Some also include the employee’s age in the calculation. According to this, the employee is entitled to 50 percent, 75 percent or 100 percent of the monthly salary per year of employment, depending on age.

In out-of-court negotiations between employer and employee, in addition to age, other factors such as performance, industry and also the employee’s negotiating skills and basis for negotiation can have an influence on the amount of the severance payment.

Bonus tip for entrepreneurs

Which salary is used for the calculation of the severance payment??
For the calculation of the severance pay you basically use the gross monthly salary. Based on this, the labor courts calculate a severance payment amount.

In the event of termination, do you know whether your employee has any outstanding leave?? With the clocko:do vacation planner you keep track of this and also the working hours!

If a severance payment is subject to social security contributions?

Severance pay is not remuneration that is subject to contributions. According to the case law of the Federal Social Court, severance pay is not assigned to the employment relationship, but is paid for the loss of the job. On the basis of this, no social security contributions are due for the severance payment. This means that no contributions for pension, nursing care, health and unemployment insurance are deducted from the severance payment.

How severance pay is taxed?

Although severance pay is not treated as remuneration in terms of social security contributions, the situation is different in the context of payroll tax. Since 2006, the tax allowance for severance payments no longer exists. Accordingly, severance payments are not tax-free, just like wages. However, the taxation of the severance pay is better off than normal remuneration. The wage tax levies of the severance pay are calculated with the fifth rule in order to reduce the tax burden.

Fifth regulation

The fifth rule, also known as the quintuple method or quintuple rule, is used to calculate taxes in the case of extraordinary income in accordance with Section 34 EStG. This must be a severance payment, which is paid for the purpose of compensation for loss of income (§ 24 No. 1 a EStG).

The fifth regulation helps to avoid a one-time high tax burden for the employee. To do this, treat the extraordinary, high income for income tax purposes as if the severance pay were divided into five equal parts and the receipt spread over the next five years.

The calculation of the tax levies using the fifths rule works as follows:

First divide the severance pay by five. Then one increases the regular annual income by one of these fifths. Due to the increase, the tax due increases. From the tax one subtracts the amount of tax that would have been due only on the pure salary. The remaining difference is multiplied by five. This will result in a lower tax burden on the severance pay.

Calculation example rule of five

Valerio is a single employee from Heidelberg with an annual income of 40.000 Euro. In 2020, he receives a severance payment of 25.000 euro. This results in 65.000 euros of annual income to be taxed (allowances and income-related expenses have already been deducted and Valerio does not receive any other income).

If one were now to calculate the tax burden without the five-period rule, one would get from the 60.000 Euro Annual income 19.344.48 euros income tax and solidarity surcharge result in. Using the fifth rule:

  1. Divide the severance pay by five: 25.000 euros / 5 = 5.000 euros
  2. Increase annual income by one-fifth of severance pay: 40.000 euros + 5.000 euros = 45.000 Euro
  3. Income tax (incl. solidarity surcharge) for increased income due to the fifth of the severance pay (45.000 Euro): 10.807,42 Euro
  4. Income tax (incl. solidarity surcharge) for the pure salary (40.000 euros): 8.916.86 euros
  5. Deduct from the tax the amount that would have been due on the salary only: 10.807.42 euros – 8.916.86 euros = 1.890,56
  6. Multiply the difference by five: 1.890,56 * 5 = 9.452.80 euros tax burden on the severance pay

Total taxation: 8.916,86 Euro (income tax of the pure salary) + 9.456.80 euros tax burden of the severance pay = 18.369,66 Euro

Total savings: 974,82 Euro

Amount of tax due on the severance pay without fifth regulation: 10.427,62 Euro (19.344,48 Euro – 8.916,86 Euro)

If the severance pay is deducted from unemployment benefits?

The severance pay has in principle no influence on the entitlement to unemployment benefits. The amount of the severance pay is also irrelevant for this claim.

Exceptions exist, however, if

  • the employee leaves the company before the end of the notice period or
  • the employee agrees a termination or settlement agreement with the employer.

Since the employee himself is responsible for the (premature) termination of his employment relationship in both cases, he must expect to suffer losses. In the event that the employee leaves the company early, he must wait for the end of the notice period to then be entitled to unemployment benefits.

If the employee has signed a termination or settlement agreement, he or she must expect a blocking period and is initially not entitled to the payment of unemployment benefits.

Katharina Bensch

Katharina Bensch is the clocko:do expert for topics related to everyday working life.
With certified expertise in legal employment topics and diverse experience as an editor, she oversees the clocko:do info portal.

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