If the employer dismisses the employee, he often compensates the loss of earnings with a severance payment. However, this is fully taxable like the annual salary. There is one exception: if the employer pays out the severance pay within one calendar year, a tax reduction is possible: the one-fifth rule.
To understand the quintuple rule, you should first know the basics about severance pay.
What is severance pay?
A severance package is a monetary payment made by the employer as compensation for the termination and the associated loss of earnings.
When is severance pay paid?
The dismissal by the employer is not reason enough. In Germany, there is no fundamental legal entitlement to the payment of severance pay. Nevertheless, there are situations in which you can claim severance pay:
Regulation by collective agreement or employment contract
Often a severance payment is provided for in a collective agreement. If there is a corresponding paragraph, then you are entitled to it. The same applies if the severance payment is stipulated in the employment contract.
Averting an action for unfair dismissal
If your employer terminates you for a business reason, you have the right to object within a fixed period of time. The consequence is an action for protection against dismissal, which robs the employee and the employer of time and nerves. To avert such a lawsuit, many employers therefore offer their employees a severance payment. This is paid on the condition that the employee does not file a lawsuit and allows the objection period to elapse.
Termination without notice by employee
If the continuation of the employment relationship is unreasonable for the employee according to § 626 BGB, the employee can terminate the employment relationship without notice for good cause. Such a case occurs, for example, bullying or sexual harassment. The dismissal is owed to the employer. Here the employee is entitled to compensation for loss of earnings and thus severance pay.
Severance pay by judicial decision
If it has come to a legal dispute, the labor court decides on the payment or non-payment of severance pay. If the dismissal was rejected and the employment relationship was not terminated, but further cooperation is no longer conceivable, there may be a claim to the severance pay. However, this is decided by the labor court in each individual case.
Social plan provides for severance pay
A social plan is an agreement between the works council and the employer. This sets out the rules for compensating for or mitigating economic disadvantages caused by a change in operations. If the employer decides, for example, to close a location, realign the core business or exclude service areas, it must compensate the employees for the financial disadvantages in return. The severance payment is clearly regulated in the social plan. Anyone who is laid off due to a change in operations should check the social plan.
Severance pay in a WORKFORCE TRANSFORMATION
In the context of a workforce transformation, there is often a large-scale reduction in the workforce. In such a case, the employer often offers the employee a severance payment. Employees receive this in the event of a voluntary termination of contract. This protects the company against a large number of dismissal protection lawsuits.
Read our case study on how a workforce reduction with volunteer program works out.
How to calculate the amount of the severance pay?
If you are entitled to severance pay, you can calculate the expected amount in our calculator:
Severance pay calculator
Note: This calculator is for guidance only and is not a legally binding calculation of severance pay. It is based on the following rule of thumb:
The factor of 0.5 is a statutory guideline that may differ in practice. In addition, individual components must be taken into account, such as minimum or maximum amounts, supplements for disability, children or single parents.
How is the severance pay to be taxed?
The severance payment is generally taxable. However, some special features apply here.
Full tax burden for severance pay
Severance payments made before 2003 were completely tax-free. Today it looks different. The severance pay is since 01. January 2006 fully liable to wage tax. The quintuple regulation gives the only chance for tax reduction.
The severance pay is exempt from social security
According to § 14 of the German Social Security Code (SGB IV SGB), wages and salaries are subject to social security contributions. A salary arises from employment with an employer. However, the severance pay is paid as compensation for the loss of earnings after the termination of the employment relationship. Accordingly, the severance payment does not fall within the scope of remuneration for work and is not subject to social security contributions. Therefore, the following social security contributions do not apply:
- Health insurance
- Accident insurance
- Pension insurance
- Unemployment insurance
- Care insurance
Voluntarily insured employees are an exception. You will have to pay additional contributions for health and long-term care insurance.
What is the one-fifth rule?
The one-fifth rule is a tax relief on a severance payment.
Based on the income, the annual tax rate increases progressively up to the top tax rate of 42 percent and from the next stage even up to the maximum tax rate of 45 percent. If the severance pay is paid, the accumulated annual income for the calendar year is significantly higher and the amount of tax payable increases accordingly. So that this effect does not weigh so heavily, there is the quintuple regulation. It splits the severance payment over five years for tax calculation purposes. This reduces the overall tax burden.
How the one-fifth settlement is calculated
The severance payment increases the tax amount for the corresponding calendar year. However, so that the tax burden is not so severe, the one-fifth rule reduces the tax burden. For this, a difference between the regular income tax and an additional one-fifth of the severance pay is calculated. This is in turn multiplied by five to calculate the total tax burden for the severance pay.
The formula for calculating the one-fifth settlement is as follows:
Est(x)= Standard income tax measured on income in the amount of x
NE= Taxable income without taking into account extraordinary income
AE=Extraordinary income (here: severance pay)
Let’s make the one-fifth rule concrete with an example:
After 20 years of employment with the company, Mr. Muller, who is single, is dismissed for operational reasons. In the social plan, the works council and the employer have agreed that Mr. Muller will receive a severance payment. He calculates the amount of his severance pay in our calculator. 3.000 € monthly gross salary x 0.5 x 20 years of service= 30.000 €
In the next step, he calculates the income tax with and without a fifth of the severance pay to calculate the difference.
|Income without severance pay||Income with one fifth of the severance payment|
|Income||36.000 €||36.000 €|
|Fifths severance payment||–||6000 €|
|Total taxable income||30.000 €||36.000 €|
|Income tax (St.-Kl. I)||3.749.47 €||5.312,98 €|
|Difference amount||1.563,51 €|
This difference is multiplied by 5 to calculate the tax burden of the total severance payment.
1.563,51 € x 5 = 7.817,55 €
The total tax burden for the corresponding calendar year amounts to the sum of the quintuple regulation and the regular income tax. Accordingly, Mr. Muller pays 11.567,02 € Taxes.
If he were to be charged the full severance payment, his annual income would be 66.000 € result. This means that Mr. Muller must pay the top tax rate and the tax office demands 15.298,55 €. With the one-fifth ruling, Mr. Muller saves a total of 3.731.48 € Taxes.
What is the requirement for the one-fifth rule?
In order for the one-fifth rule to apply, a number of requirements must be met:
Payment within one calendar year
The severance pay must be paid in full as a one-time payment or by several partial payments within one year. However, the tax offices accept a small partial payment outside the calendar year, which may not exceed five percent of the total severance payment. By an agreement with your employer, you can postpone the payment of the severance pay to the following year and thus receive the tax advantage due to the one-fifth rule.
Accumulation of income
There must be an aggregation of income. This is the case when the income together with the severance pay is higher than the income if the employment relationship is continued.
Ms. Petersen earns a monthly gross salary of 3.000 €. After 10 years of service, her employer terminates her employment for operational reasons in March and offers her a severance package.
With the severance calculator it calculates a severance amount of 10.000 €. Together, their salary and the severance pay add up to 19.000 €. If she had worked the whole year for her employer, her gross annual salary would be 36.000 € would amount to. Accordingly, in the case of Ms. Peters, there is no aggregation of income and no tax savings due to the one-fifth rule.
Not applicable for contractually agreed severance payments
If the employment contract or the collective agreement provides for a severance payment upon termination of the employment relationship, no tax reductions may be claimed under the one-fifth rule.
What are the special features of the one-fifth rule?
Those who receive the severance pay in a year in which they did not work can be happy. The tax rate is much lower and the income and the severance pay do not add up for the tax calculation. Compared to a person who has worked, the tax burden is then lower.
For people who receive a wage replacement benefit the opposite is the case. Unemployment benefit, sick pay, parental allowance or transitional allowance are subject to the progression proviso. Accordingly, the wage replacement benefits themselves are tax-free, but indirectly increase the tax burden. They are added as income when calculating wage tax. Although no income was received, the tax rate increases and thus the tax reduction is reduced.
When does a one-fifth rule make sense??
The quintile rule is always more favorable. Employees and unemployed who receive wage replacement benefits benefit from the scheme. With one exception:
If you are within the top or maximum tax rate, the fifths rule may have no effect. Once the maximum tax rate has been reached, it doesn’t change – even with the severance pay.
How does the company pension quintuple regulation work?
The company pension plan ensures you an additional pension. The state encourages this in the savings phase through tax benefits. However, when the benefits are paid out, they have to be taxed. Tax savings are also provided here by the five-percent rule. However, this only applies if it is a one-time payment. The calculation is done according to the formula of the five-part regulation. Instead of one fifth of the severance payment, one fifth of the company pension is calculated here.
Where do I apply for the quintuple regulation?
In principle, you do not have to apply for the one-fifth rule. your employer is obliged by law to apply the quintuple regulation when paying out the severance pay, insofar as you gain a tax advantage. You can see on the pay slip whether the five-percent rule has been applied. If your employer has mistakenly not applied the five-percent rule, the money is not gone. Through the annual income tax return, you can apply for the quintile rule retroactively and get the tax difference back.
Note: This is a purely informative text and not a tax advice. Please consult labor law experts for tax-related questions.