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Severance Pay: The Most Important Information on the One-Fifth Rule

The early termination of employment by the employer is usually painful for the employee concerned. To ensure an amicable separation, the employee is often given a golden handshake. Compensation is provided for the loss of employment, which is also taken into account for tax purposes with tax benefits.

What amount of severance pay should be assumed?

According to Section 1a of the Employment Protection Act (KSchG), all employees are entitled to severance pay in the event of redundancy. A voluntary severance offer must be forwarded to the employee together with the notice of termination. However, the condition for receiving the severance pay is that the employee does not contest the termination. The amount of severance pay is based on the number of years of employment with the company.

There is usually an entitlement to half a month's salary for each year of employment. For ten years of service, there is an entitlement to an amount equivalent to five months' salary. In addition, there are claims from benefits in kind provided by the employer. If a company car or company laptop was provided, the value of use must be added to the calculation of the severance pay amount. Certainly, lower or higher severance payments are also possible, but these are usually not redundancy but rather a settlement or severance agreement.

Tax treatment of the one-fifth rule

Since the Tax Amendment Act 2001, the consideration of the one-fifth rule no longer needs to be applied for. The tax office automatically checks whether normal taxation or the reduced taxation according to the one-fifth rule is more favourable for you.

Important: If severance pay or remuneration for work over several years has been taxed by the employer according to the one-fifth rule, you are obliged to submit a tax return.

This is how the tax liability is calculated with the one-fifth rule

• The taxable part of the extraordinary income (severance pay, jubilee bonus, remuneration for work over several years, etc.) is deducted from the taxable income.
• The income tax is calculated for the remaining taxable income according to the applicable tax rate.
• The severance pay is divided by 5 and one-fifth is added to the remaining taxable income.
• Income tax is calculated again for the sum according to the tax rate.
• The difference between the two tax amounts is calculated and multiplied by 5.
• The result is the income tax on the extraordinary income.

A married employee receives severance pay of 50.000 Euro in the year 2024. The taxable income amounts to 70.000 Euro. The taxable income is increased by one-fifth of the severance pay (i.e. 10.000 Euro):

• Income tax (splitting rate) on 70.000: 11.850 Euro
• Income tax (splitting rate) on 80.000: 14.990 Euro
• Difference 3.140 Euro
• Income tax on the severance pay: (3.140 Euro x 5 =) 15.700 Euro
• Total income tax: (11.850 Euro + 15.700 Euro=) 27.550 Euro

Does the one-fifth rule also apply in the case of resignation?

The Münster Finance Court ruled in 2017 that severance pay is also eligible for tax relief under the one-fifth rule in accordance with Section 34 (2) EStG if the employee initiated the termination agreement. In the case under review, the employee was under the significant actual pressure required by the BFH case law when concluding the termination agreement, as he acted in a conflict situation to avoid disputes about the continuation of the employment relationship and the promotion he sought (FG Münster of 17.3.2017, 1 K 3037/14 E).

Currently, the BFH has shared this view and dismissed the tax authorities' appeal. It follows that if an employer pays an employee severance pay as part of the (amicable) termination of employment, actual findings on whether the employee was under actual pressure are generally unnecessary (BFH ruling of 13.03.2018, IX R 16/17, BStBl 2018 II p. 709).