Severance pay and taxes – give me the one-fifth rule

Think positively – even in a crisis. Who threatens the loss of its job, can perhaps at least still a compensation rausschlagen. Sounds good at first, but then the question arises: Do I have to pay tax on the extra money?? And if so, how? What exactly is the one-fifth rule? We explain what is involved. Easy to understand, of course.

Just briefly, before we get started: Unfortunately, we cannot give any advice on how high a severance payment should be. There are many factors that play into this, so get advice, for example from your trade union. However, you should not accept the employer’s first offer right away, as you can usually get more out of it.

Good news and bad news

Okay, let’s be positive: if you receive a severance payment from your former employer, you usually don’t have to pay any social contributions on it (such as for pension or health insurance).
In the case of statutory health insurance, an exception can occur if you continue to insure yourself there voluntarily.
There are no exceptions – and this brings us to the bad news – when it comes to taxes: severance pay must be taxed. There is no way around it.

Extraordinary income

That sounds really steep at first. Because if you receive a nice severance pay and also earn "normally" in that year, probably a pretty big part of the severance pay would go to the taxman. Dignity, because there is a way out after all. This is due to the fact that severance payments count as so-called extraordinary income. Fortunately, there is a special tax solution for this, which we will now discuss. The one-fifth rule.

What is the principle of the quintuple regulation?

The explanation is already in the term: The severance pay is divided into fifths and treated in such a way, as if it would be distributed in fifths tidbits over five years. The advantage: Since the tax rate increases with rising income, the tax decreases when the severance pay is divided into fifths.
If you’re saying, "All right, I’ll always have to pay tax on one fifth of the severance pay in addition to my salary over the next five years," you’re sadly mistaken.
Of course, the tax office does not want to wait five years for its taxes for an income that you received at the beginning of this time.
So here’s what happens: In the year in which you receive the severance pay, one fifth of it is added to your taxable income. Then the tax is calculated from this total amount. And at the same time the tax you would have to pay on your "normal" income. The difference between these two figures multiplied by 5 is the tax on your severance pay. Sounds complicated at first, but we will show you two examples in a moment, then it will become clearer.

This is how the quintile rule works – example 1

A rule of thumb in advance: the lower your taxable income, the more worthwhile the one-fifth rule is.

An employee has a taxable income this year of 36.000 euros. At the end of the year, he is dismissed and receives a severance payment of 40 in December.000 euros.

The tax on the "normal" income of 36.000 euros would be 7.485 euros (including solidarity surcharge).

One fifth of the severance pay (40.000 Euro) are 8.000 euros. The "normal" income (36.000 euros) plus the fifth (8.000 Euro) are 44.000 Euro. This would require taxes of 10.420 Euro due.
The difference between the two tax amounts is 2.935 euros. Now we have to multiply this again by five. This results in 14.675 euros. So on the severance pay 14.675 euros to pay. So in total with the "normal" tax it is 22.160 euros.

By way of comparison: If the one-fifth rule did not exist, 36.000 plus 40.000 euros, i.e. 76.000 Euro will be taxed. That would be a proud 24.219 euros. Thanks to the one-fifth rule, the employee has 2.059 euros saved on taxes.

But there is a way to save even more, as we will see in a moment.

How the one-fifth rule works – Example 2

The employee negotiates that the severance pay will not be paid until January 2021. In this year he takes a job, which is however clearly worse paid than the previous one. His taxable income drops to 24 in 2021.000 euros. The severance pay remains at 40.000 euros.

The tax on 24.000 Euro is only 3.346 Euro, the Soli is then omitted.

Now we calculate the tax from income plus fifth of the severance pay. That is 32.000 euros (= 24.000 euros + 8.000 euros). The tax then amounts to 5.706 Euro. Then again quickly form the difference and multiply by five – results in 11.800 euros (5.706 Euro – 3.346 Euro = 2.360 euros, 2.360 Euro x 5 = 11.800 euros). Compared to example 1, this is almost 3.000 euros less in taxes for the severance pay. This is due to the lower income – and the omission of the Soli.
The employee would have to pay a total of 15.146 Euro (= 3.346 euros + 11.800 euros) pay taxes.

Also here the comparison without the fifth regulation: Then would have to pay 64.000 euros to be taxed – makes 17.837 Euro Taxes. Here the employee saves even 2.691 euros.

And if all this is too complicated for you: The best way to do your tax return is with our online solution smartsteuer . Because you only have to enter the amount of the severance pay – the rest is done by the program.

What does this mean concretely for me?
If you receive a severance pay, you have to pay tax on it. Thanks to the quintuple rule, however, it is less tax than with "normal" taxation. If you know that you will no longer have such a well-paid job after leaving your old company, you should, if possible, take the severance pay into the next year. This is even doubly worthwhile, since next year the Soli will no longer apply to the vast majority of employees.

Stefan, as a specialist lawyer for tax law, understands even the laws that make their own authors despair. He disproves the rumor that lawyers can’t do math – to the delight of our customers and the annoyance of the tax office. As managing director of smartsteuer, Stefan keeps the team together with his harmonious manner and focuses it on the common goal: The simplest tax return.

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