EMPLOYMENT LAW · BERLIN
Taxation of severance payments in Germany: What employees should know
A severance payment is often an important part of a settlement after a dismissal or in connection with a termination or settlement agreement. In practice, the focus is often on the gross amount. However, employees should keep in mind: severance payments are generally taxable in Germany.
This means that the agreed severance amount is usually not paid out net in full. It is generally treated as taxable income and must be taxed in the year in which it is received.
Is there a tax benefit?
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.
When can the one-fifth rule be relevant?
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.
Not every payment made in connection with the end of employment automatically qualifies for favourable tax treatment. For example, ordinary salary arrears, outstanding commissions, bonuses, holiday pay or other claims that were already owed under the employment relationship are usually treated differently.
The key distinction is therefore this: a genuine severance payment for the loss of employment may be treated differently for tax purposes than the mere payment of remuneration that has already been earned or become due.
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.
Why does the payment date matter?
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.
What applies from 2025?
Since 2025, the one-fifth rule is generally no longer applied by the employer in the wage tax deduction procedure. Instead, it is examined as part of the employee's income tax assessment. In practice, this means that employees usually have to claim the potential tax relief through their tax return.
This may mean that any tax relief is not visible immediately when the severance payment is paid, but only later as part of the tax assessment.
Should I seek tax advice before signing an agreement?
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.