Taxation of severance payments in Germany: What employees should know

Previous tax allowances for severance payments no longer apply. Severance pay is therefore generally taxable.

Under certain conditions, however, the so-called one-fifth rule may apply. It is intended to reduce the additional tax burden that can arise when a larger one-off payment is received in a single calendar year.

The one-fifth rule does not mean that the severance payment is paid out over five years or taxed over five years. The severance payment is generally taxed in the year in which it is received. For the tax calculation, however, the tax effect of one fifth of the severance payment is calculated and then multiplied by five.

Important: the one-fifth rule does not automatically result in a significant tax saving. Whether it has a noticeable effect depends heavily on the individual case, especially on the employee's other income in the year of payment and on the amount of the severance payment.

Not everything labelled as "severance" in an agreement is necessarily treated as a favourably taxed severance payment. For example, outstanding salary, bonuses, commissions, vacation pay or other remuneration that has already been earned may be treated differently for tax purposes.

The key point is this: a genuine severance payment for the loss of employment must be distinguished from the payment of remuneration that was already earned or due. If different claims are combined into one amount, employees should have the structure reviewed before signing.

The tax relief may typically be relevant if the severance payment is made as compensation for the loss of employment. In other words, it must compensate for income that has been lost or will be lost.

The fact that severance pay is taxable does not automatically mean that it is subject to social security contributions. A genuine severance payment for the loss of employment must be distinguished from salary components such as outstanding wages, bonuses or vacation pay.

The timing of the payment can also be important for tax purposes. The one-fifth rule generally requires a concentration of income. Put simply, the severance payment must usually be made as an extraordinary one-off payment in one calendar year.

If payments are spread across several calendar years or additional amounts are paid later, this may be relevant for tax purposes. For that reason, the payment date should be considered carefully before entering into a termination, settlement or separation agreement.

In termination agreements, settlement agreements or court settlements, it should be clear whether the severance amount is meant as a gross or net amount. In practice, severance payments are usually agreed as gross amounts.

This means that the employer withholds wage tax and pays it to the tax authorities. Economically, however, the tax burden is generally borne by the employee. Employees who want to know what amount may remain net should seek tax advice.

Since 2025, employees should not simply assume that the employer will apply the one-fifth rule in the wage tax deduction procedure. The one-fifth rule is generally no longer applied by the employer when withholding wage tax. Instead, potential tax relief is examined as part of the employee's income tax assessment.

In practice, this may mean that more wage tax is withheld when the severance payment is paid out, and any relief may only become visible later in the tax assessment.

In cases involving higher severance payments, tax advice can be useful. The timing of the payment, the distribution of individual payments or the combination with other benefits can have significant financial consequences.

I support employees with the employment-law assessment and negotiation of dismissals, termination agreements and severance payments. The specific tax calculation should, however, be reviewed by a tax adviser or as part of the income tax assessment.