Severance Pay and the One-Fifth Rule – Key Information on Tax Treatment

The termination of employment can be accompanied by a severance payment for employees. This one-off payment is taxable, but under certain conditions, it can be taxed at a reduced rate using the one-fifth rule.

Entitlement to severance pay after redundancy

According to Section 1a of the Employment Protection Act (KSchG), employees are legally entitled to severance pay in the event of redundancy if they do not file an unfair dismissal claim. The amount is usually based on the length of service:

• 0.5 months' salary per year of employment
  Example: For 10 years of service, the severance pay is 5 months' salary.

Benefits in kind (e.g. company car or laptop) can also be included in the calculation.

Different regulations apply to settlement or termination agreements, especially if initiated by the employee.

How does the one-fifth rule work?

The one-fifth rule under Section 34 of the Income Tax Act (EStG) reduces the tax burden on extraordinary income (e.g. severance payments). Since the Tax Amendment Act 2001, the tax office automatically checks whether the application is more favourable.

Note: If the one-fifth rule is applied, there is an obligation to submit a tax return.

This is how the tax liability is calculated with the one-fifth rule

• The taxable part of the extraordinary income (severance pay, jubilee bonus, remuneration for multi-year work, etc.) is deducted from the taxable income.
• The income tax is calculated for the remaining taxable income according to the applicable tax rate.
• The severance payment is divided by 5 and one-fifth is added to the remaining taxable income.
• The income tax is then calculated for the total according to the tax rate.
• The difference between the two tax amounts is calculated and multiplied by 5.
• The result is the income tax on the extraordinary income.

Example: A married employee receives a severance payment of 50.000 Euro in 2025. The remaining taxable income is 70.000 Euro.

• Tax on 70.000 Euro: 11.850 Euro
• Tax on 80.000 Euro: 14.990 Euro
• Difference: 3.140 Euro
• Tax on severance payment: 3.140 Euro × 5 = 15.700 Euro
• Total tax: 11.850 Euro + 15.700 Euro = 27.550 Euro

One-fifth rule also possible with voluntary termination agreement

The one-fifth rule can also apply to an amicable termination of contract, even if initiated by the employee. This was confirmed by the Federal Fiscal Court (BFH) in its ruling of 13.03.2018 (Ref. IX R 16/17, BStBl 2018 II p. 709). Specific external pressure no longer needs to be established.

End of the one-fifth rule in the payroll tax procedure from 2025

Since 01.01.2025, the application of the one-fifth rule is no longer possible in the payroll tax deduction procedure. This was decided as part of the bureaucracy reduction through the Growth Opportunities Act (from 27.03.2024). Employers no longer carry out checks and calculations. The one-fifth rule is only considered as part of the tax return.