A severance payment is intended to make the termination more bearable. However, this extra payment must be fully taxed. So there is less left over. It is not uncommon for the tax rate on the total income to increase. The so-called one-fifth rule is a tax trick. This significantly reduces the deductions. Effect: The tax burden is reduced and you have to give less of the settlement to the tax authorities. We explain how the tax trick works, how to apply for and apply the fifth..
➠ Contents: What you can expect
What is the quintuple regulation?
If you lose your job, you sometimes receive a severance package with your notice. There is no entitlement to this. However, if you receive a severance payment, you must pay tax on this "extraordinary income" as a matter of principle. The problem: The comparatively high one-time payment often increases the tax rate. This leaves you with even less of the payment (and the income).
The quintile regulation offers a chance for tax reduction. The severance payment is spread over five years, thus slowing down the tax progression. Effect: Only one fifth of the severance payment amount is added to the income per year. The tax rate thus usually remains the same or increases only slightly.
Taxation of extraordinary income
Extraordinary income is income that is earned over several years but paid out in a single calendar year. This can be overtime pay and commissions – or severance pay. After all: No social security contributions are due for the severance pay in accordance with Section 14 of the German Social Security Code (SGB IV SGB). This means that you do not have to pay unemployment, health, nursing care, pension or accident insurance for it.
Sole exception: Voluntarily insured persons must pay health and long-term care insurance contributions.
Is the quintuple settlement automatically applied?
You do not have to apply for the one-fifth rule. In principle, it is initially the responsibility of the employer to apply the five-percent rule when paying out severance pay, if this gives you an advantage. The salary statement should show that the employer has included the one-fifth rule in the calculation.
Attention: Anyone who, as a taxpayer, takes advantage of the tax reduction through the one-fifth rule in accordance with sections 34 and 24 1a of the German Income Tax Act (EStG) is obliged to submit a tax return! You yourself must then also declare the one-fifth rule in your tax return. This happens in the plant N.
Pay attention to the correct line! If the quintuple rule was applied, the value goes on line 17 "Reduced tax compensation / wages for several years". Without tax reduction, enter it on line 18 "Compensation / wages for several years".
Fifth rule calculator: This is how the tax trick works
If the quintuple rule is applied, multiple calculations are performed:
- First, the amount of the severance pay is divided by 5 and added to the annual salary. The tax burden is calculated for this total income.
- In the second step, the income tax to be paid without severance pay is calculated. This is deducted from the wage tax on the annual gross salary (including severance payment fifth).
- The difference is multiplied by five and results in the new tax to be paid on the severance payment. In a direct comparison, more net remains from the gross thanks to the one-fifth rule.
The effect is usually already explained by the different progression of the tax rates.
Fifths rule Example: Calculation of tax
In our example we assume an unmarried man (tax class 1). The employee is to be terminated and receives a termination agreement with a generous severance payment. The taxable annual income is 46.000 euros. He agrees with his former employer on a severance payment of 20.000 Euro.
The following calculation shows the effect of the one-fifth rule:
When is the one-fifth rule more favorable?
Taxpayers with a low taxable income have the greatest advantage. Taxing the severance payment in full can lead to a significantly higher tax rate here. However, this effect decreases with increasing income.
When is the one-fifth rule not worthwhile?
A person who already pays the top tax rate of 45 percent on his annual income does not benefit at all from the one-fifth rule. Whether the additional compensation amount falls on one calendar year or is spread over five years: It does not change the maximum tax rate.
Requirements for the one-fifth rule
In order for you to benefit from the tax advantages of the one-fifth rule, certain conditions must be met:
- You receive a severance payment as compensation for a dismissal.
- You do not file an action for protection against dismissal.
- The employer has terminated the employment relationship.
- The severance pay is a one-time payment.
- The one-time payment is recorded as extraordinary income.
Entitlement to severance pay?
As mentioned above, there is NO entitlement to severance pay. This is a voluntary payment by the employer. This is often used to make a termination agreement more palatable to employees. Or in the case of redundancies for operational reasons, in order to cushion social hardship in the event of job loss. Whether you receive a severance payment, and if so, how much, therefore depends primarily on your own negotiating skills (or a court ruling).
Exceptions: When is the one-fifth rule not applied?
In addition, there are exceptions and special cases in which the one-fifth rule is not applied. You should know these:
- Severance pay is fixed from the outset
If there is a clause in the employment contract that guarantees severance pay in the event of dismissal, the one-fifth rule cannot be applied. This is the result of a ruling by the Munich Fiscal Court (Ref. 16 K 4486/97). - The severance pay is not
If employees are paid an amount at the end of employment that represents compensation for work already performed or a bonus payment, it is not severance pay. So there is no quintuple regulation on it. - Employee remains in the company
If the employee merely changes his position in the company or is transferred to another location, this does not justify the application of the one-fifth rule. The original employment relationship continues in these cases. There is no reason for a "severance pay" in the sense of the regulation. - No accumulation of income
The income including severance pay must be higher than the income when remaining in the company. An example: With 3.000 monthly salary, the income over the entire year is 36.000 euros. If notice is given in April and a severance payment of 8.000 euros negotiated, income (3 times 3.000 + 8.000 euros) only 17.000 euros – significantly less than 36.000 Euro. Effect: The one-fifth rule cannot be applied.
One-fifth rule in the case of self-termination?
Tax reductions due to the one-fifth rule are not provided for in the event of self-termination. In this case, the employee terminated the employment contract on his own initiative. In this case, the employer does not have to pay any severance pay at all. There is even a threat of up to 3 months of ALG 1 blocking.
Exception: The employee had to resign. For example, out of pure self-protection. If the employee gives justified notice of termination without notice (for example, because of bullying or health hazards), the employer may be obligated to pay severance pay in accordance with Section 628 of the German Civil Code (BGB). The five-percent rule can then be applied to this again. However, such special and individual cases are usually decided in court. In this case, we recommend consulting a specialist attorney for employment law as well as an expert for tax law.
Alternative: Investing severance pay for retirement
Instead of having the severance pay paid out, employees can also invest part of their severance pay in the company pension plan.
Deposits can be tax-free, However, you must pay tax again on a company pension paid out at a later date. Company pension plans include, for example, pension funds, pension funds and direct insurance policies that are invested using the funded method.
The maximum tax-free amount is 4 percent of the income threshold multiplied by the number of years of employment (up to a maximum of 10 years).
Have severance pay paid out in the following year
If the notice of termination is given towards the end of the calendar year and there is no new job immediately in sight, another trick may be worthwhile: Severance pay can be paid out only in the following year upon request. This is particularly worthwhile if your income is lower in the following year. If the one-fifth rule is also applied, the former employee can benefit twice from the tax relief.
If employees receive part of the severance pay already want to receive in the current calendar year, this is also possible. Up to ten percent of the severance pay may be carried over into the following year. This also reduces the tax burden without risking the application of the one-fifth rule.
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