Those who receive severance pay as employees must pay full tax on it. A not inconsiderable part of the severance pay is lost due to the tax liability – this dampens the joy about the compensation payment for many affected persons. As reduced taxation, the quintuple regulation reduce the tax deductions. We will tell you under what conditions you can use the quintuple rule in the case of severance pay, how to do it and when it makes sense to have the severance pay paid later by the former employer.
What is the rule of five and what is it for??
When an employment relationship ends, employers sometimes pay severance to former employees. The special payment can be agreed for example in the context of a termination agreement or a settlement. Also in the case of layoffs and extraordinary cancellations by the employee, employees have under certain conditions are entitled to receive compensation. For the departing employees, the transition is eased by the compensation payment, the loss of the job and the loss of the salary are compensated to a certain extent.
Social security contributions are not normally due on the special payment. There is an exception if you have voluntary health insurance. If you receive a severance payment from your employer, you have to pay it according to the Income Tax Act (EStG), however, fully taxed. Thus result in part high deductions from the agreed gross amount. Problematic for affected persons is especially that the high income can result in a higher tax rate. The tax progression ensures that increasing income is taxed at a higher rate. This is exactly what the one-fifth rule is supposed to prevent.
How is the tax liability calculated in the case of the one-fifth rule under the EStG?
The quintuple regulation is a procedure in tax law. It is regulated in section 34 of the Income Tax Act (EStG). The quintile regulation effects in most cases that the Tax burden reduced in case of extraordinary income becomes. This is ensured by a special method of calculating the tax burden.
To determine the tax liability after receiving a severance payment or other extraordinary income, the Settlement amount by five shared. The result is added to the regular income. The tax administrator then compares the income tax resulting from the total income (including severance pay) with the income tax that would be due without the severance pay.
The difference between the tax burden on an income with and without severance pay is the additional tax burden that would have resulted if the employee had received only one fifth of the severance pay. The additional burden is therefore multiplied by a factor of five to obtain the income tax that would have been due on the severance pay.
This calculation usually leaves you with more of your severance pay and reduces the tax deductions. The quintile rule benefits especially Workers, who receives one Comparatively low income have, which leads to a low rate. Without a quintile system, they would be subject to a significantly higher tax rate. For high income workers, the difference is often less.
Five-percent regulation: Example for the reduced taxation of severance pay
To illustrate the effect that the one-fifth rule has on the taxation of severance pay, let’s imagine the following example. Jens earns 4 per month.000 euros gross. On his annual income of 48.000 euros fall in 2020 8.077 Euro wage tax to. He receives a severance payment from his employer in the context of a termination in the amount of 50.000 euros. To determine the wage tax, the quintuple rule is applied and the severance payment amount is divided by five. It is then added to Jens’ regular annual income. His total taxable income would then be 48.000 + 10.000 Euro = 58.000 euros. The wage tax amount due on this is 11.142 euros.
Now the difference between the two wage tax amounts is calculated: 11.142 – 8.077 euros = 3065 euros. Multiplying by a factor of 5 results in the wage tax payable on the severance payment: 3065 x 5 = 15.325 euros.
By comparison, if the one-fifth rule had not been applied, Jens’ taxable income would have been 48.000 + 50.000 = 98.000 euros gross. This would have resulted in a wage tax amount of 26.970 euros. With the one-fifth rule, this results in a tax burden of 8.077 + 15.325 = 23.402 euros. The quintile regulation is therefore more favorable for him; it leads to a tax advantage of 3.568 euros.
One-fifth rule: When is it applicable??
Legally, a severance payment is extraordinary income. This includes various types of income, usually earned over a longer period of time, but paid out collectively at a certain point in time. Extraordinary income is eligible for tax relief; Affected persons can use a Tax reduction benefit. Most employees who have received severance pay benefit from the one-fifth rule.
Those who have received severance pay can benefit from the one-fifth rule if the severance pay compensates for lost or missing future income – this is typical in the context of severance pay in the event of a dismissal. However, the tax reduction can only be applied under certain conditions.
The payment period of the severance pay plays a particularly important role here. Typically, employers pay out such compensation to former employees on a one-time basis. If the special payment thereby results in Accumulation of income in one assessment period the income tax is calculated according to the fifths rule. This criterion is met if you have higher income as a result of the severance payment than would have been the case if the employment relationship had continued. The compensation is then higher than the loss of income due to the termination.
If the former employer transfers the severance pay to you in partial amounts, this jeopardizes the more favorable taxation under the one-fifth rule. A limit of ten percent applies: you can carry forward up to ten percent of the severance payment to the next calendar year and still benefit from the one-fifth rule. Splitting the severance payment amount into larger parts, on the other hand, would mean that the tax reduction can no longer be used.
One-fifth rule: Further requirements for application
Another condition for the use of the one-fifth rule is that the employee has not contributed to the cause of the loss. His situation must have arisen as a result of the employer’s actions.
The prerequisites for the application of the one-fifth rule also apply in the case of an agreement on a severance payment in the context of a termination agreement usually given. According to a ruling by the Munster Fiscal Court in 2017, the one-fifth rule must also be applied as a tax reduction if a termination agreement was reached at the employee’s instigation.
The court had ruled that the employee had acted under considerable pressure – a prerequisite for the application of the one-fifth rule. The Federal Fiscal Court also ruled in March 2018 that the question of whether the employee was under pressure is regularly dispensable in the case of a severance payment with regard to reduced taxation.
The one-fifth rule does not apply in the event of a change of employment or if the employment relationship continues in some other way. Also, if the special payment is not severance pay, but rather payments made elsewhere – such as salary or bonuses that have not yet been paid – the reduction will not be eligible for.
Applying for the one-fifth rule: Is it necessary??
If you received a severance pay and want to use the one-fifth rule for reduced taxation, you normally don’t have to apply for it separately. The tax office automatically checks which taxation is more favorable for you after receiving your tax return. Employers are also obliged to use the one-fifth rule when paying severance pay. Only if it is not apparent to the employer that the compensation results in an accumulation of income – for example, because this only arises from further income – must employees apply for the one-fifth rule themselves.
Anyone who has received a severance payment that has been taxed according to the one-fifth rule is required to file a tax return. you have to declare the settlement amount in the tax return. The correct form for this is Schedule N, more precisely lines 17 – 20 ("Wages for several years/compensation"). Whether the compensation has already been taxed by the employer according to the one-fifth rule can be seen from the wage tax certificate. If the one-fifth rule was applied, you will find the corresponding amount on line 10. If the employer has not reduced the severance pay, but has paid regular full tax on it, the information belongs on line 19 of Schedule N.
Five-percent rule: severance pay can only be paid out at a later date?
It may make sense to agree with the employer that the severance pay will not be paid until the following year. This may be especially true if worthwhile, if you do not yet have a new job after termination and it is expected that you will be able to invest tax-free in a company pension plan next year lower income Will have more money than in this. This can result in a significantly lower overall tax burden.
Alternatively, it is also conceivable to postpone payment of ten percent of the severance amount until the following year. However, no other splitting is possible – it would lead to the fact that the one-fifth rule can no longer be used, even if the requirements for this are otherwise met.
Use severance pay for retirement and save taxes
Instead of cashing out the settlement, you may decide to put the compensation into your retirement plan. The advantage: The severance pay can tax-free into a company pension scheme be converted. The tax-free credit has been possible since 2018 in accordance with the Betriebsrentenstarkungsgesetz (Company Pension Strengthening Act). The severance payment can be paid into a direct insurance policy, a pension fund or a pension fund in this context. However, this is only possible if the maximum amount has not yet been exhausted.
It is also conceivable that the severance payment amount is split. Thus, an employer can pay half of the compensation into the pension scheme tax-free. The other part is paid to the employee. The sum paid out is taxable; however, the one-fifth rule can be applied if the requirements are met.