Severance payment and one-fifth rule: When does the reduced tax rate apply?

In the event of early termination of employment, employees often receive a severance payment. Since 2006, this is no longer subject to a tax allowance, but it can still be taxed at a reduced rate under the so-called fifth rule (§ 34 EStG) – under certain conditions.

Conditions for applying the fifth rule

For the reduced taxation to apply, the following conditions must be met:

The severance payment is paid in a lump sum in one calendar year.
The annual income with severance payment must be higher than the income that would have been earned if the employment had continued uninterrupted.

The aim of this regulation is to mitigate the progressive effect of the income tax rate when exceptionally high income is received in one year due to the severance payment.

No tax advantage for low severance payment

The fifth rule does not apply automatically. This is shown by a ruling of the Federal Fiscal Court on 08.04.2014 (Az. IX R 33/13):

With a gross salary in the previous year of around 140.000 Euro and a severance payment of 43.000 Euro, there is no “lump sum” increase in income.

→ The fifth rule is not applicable.

Reason: The income in the severance year was not higher than if the employment had continued as normal. Therefore, there was no progressive tax disadvantage.

Comparison calculation: “Actual amount” vs. “Target amount”

Whether the fifth rule is applicable is checked by means of a comparison calculation:

Actual amount: Actual income in the year of the severance payment (including severance payment)
Target amount: Fictional income if employment had continued until the end of the year (e.g. based on the previous year's income)

Note:

If the severance payment does not exceed the lost income until the end of the year, further income may be taken into account that would not have been received without the termination of employment – e.g. unemployment benefit.

Example:

Mr M. ended his employment in June 2025 and received a severance payment of 35.000 Euro. His regular annual income would have been 70.000 Euro.

In the severance year, he only earns 25.000 Euro in wages plus the severance payment. The total income is 60.000 Euro – and thus below the income if he had continued working without interruption.

The fifth rule cannot be applied as there is no progressive disadvantage.