Termination agreement – secure tax benefits for severance pay

If your employer has forced a termination agreement on you and pays you a severance payment, you must observe a few tax rules so that the tax office taxes this severance payment favorably. If the severance payment is taxed according to the so-called fifth method, you can save a few hundred or even a few thousand euros in taxes.

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Tax allowance for termination agreement with severance pay

If your employer gives you notice and you sign the termination agreement for your employment relationship only because he pays you a lucrative severance pay? Then you should be fiscally smart, so that as much as possible of your severance payment remains for you. Because the severance payments are taxable. However, if you meet a few conditions, you will be eligible for preferential taxation.

A severance payment from a termination agreement is taxed favorably according to the so-called fifth method if the following conditions are met:

  • The severance payment must be a compensation payment.
  • This is the case if the severance payment leads to an accumulation of income within one tax year.
  • An accumulation of income generally requires that the severance payment from the termination agreement is paid out in one lump sum and is higher than the lost wages for the remaining months of the year.

If the severance payment from the termination agreement is to be paid in two installments in two different years, the preferential taxation of the severance payment according to the fifth method is generally excluded. But no principle without exception.

Severance payment from termination agreement in several installments

If your former employer wants to pay you your severance pay from the termination agreement in two installments in two different years, the preferential taxation of the severance pay is not lost in the following two cases:

  • Variant 1: One of the two installments may not exceed 10% of the main severance payment or
  • Variant 2: One of the installments is less than the standard tax allowance for the main payment.

Example of variant 1:

In the termination agreement, your boss offers you a severance payment of 20.000 euros, payable at the end of the year with 1.500 Euro and at the beginning of the next year with 18.500 euros. Consequence: Here, the more favorable taxation of the severance pay according to the fifth method would still be exceptionally possible despite payment of the severance pay in two different years, because one installment would not exceed 10% (would be 2.000 euros) of the main severance payment.

Example of variant 2:

You receive in the termination agreement a severance payment of 12.000 euros awarded. A rate of 2.You will receive EUR 000 in the current year, and the remaining severance pay of EUR 10,000 will be paid to you.000 euros next year. The tax reduction under the fifth method for the main severance payment would be 2.700 euros. Consequence: Since the first installment of the severance pay is less than the tax reduction from the main severance pay, the more favorable taxation also comes into consideration in this case.

Practical tip:
You do not need to worry about whether one of the two conditions is fulfilled. If you have already received your severance installments from the termination agreement, you only have to make the necessary entries for taxation according to the fifth method in the input masks of the QuickSteuer tax software. With this information the tax office then checks the conditions for the favorable taxation.

Apply for church tax waiver on severance payments from termination agreement

If you are liable to church tax, church tax will also be due on your severance payment from the termination agreement. However, you need to know that the church tax offices generally waive 50% of the church tax for such extraordinary income upon request. Although this is not stated in the church tax laws, it is applied in practice.

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