Discrimination: Employer's compensation completely tax-free

Under the General Equal Treatment Act (AGG), discrimination on grounds of race or ethnic origin, gender, religion or belief, disability, age, or sexual identity is prohibited (§ 1 AGG). If the prohibition of discrimination is violated, the employer is obliged to compensate for the resulting damage. The person affected can claim an appropriate monetary compensation (§ 15 para. 2 AGG). The question is how such compensation is treated for tax purposes. Recently, the Rhineland-Palatinate Fiscal Court ruled that compensation paid by an employer to an employee due to discrimination, bullying, or sexual harassment is tax-free and not taxable wages. This applies even if the employer denied the alleged discrimination and only agreed to the payment in a court settlement. Tax-free means that the payment is not subject to social security contributions (Rhineland-Palatinate Fiscal Court, 21.3.2017, 5 K 1594/14).

The case: An employee filed a unfair dismissal claim against the termination of her employment for "personal reasons", also seeking compensation for discrimination due to her disability. A few weeks before the dismissal, the Office for Social Affairs had determined a physical disability of 30%.

Before the Labour Court in Kaiserslautern, the employee and her employer reached a settlement in which "compensation according to § 15 AGG" of 10.000 Euro was agreed, and the employment relationship was terminated by mutual consent. The tax office wanted to treat the compensation as taxable wages.

According to the tax judges, the settlement reached at the Labour Court indicates that the payment was not compensation for material damages under § 15 para. 1 AGG (e.g. lost wages) but for non-material damages under § 15 para. 2 AGG due to discrimination against the claimant as a disabled person. Such compensation payments are tax-free and not to be classified as wages. The claimant's employer had denied the discrimination.

However, as part of the settlement, he was willing to pay compensation for (only) alleged discrimination. Such income does not have the character of wages and is therefore tax-free.

The compensation is not only tax and social security-free, but it is also not included in the progression clause, so it does not lead to a higher tax rate for other income.

The Federal Administrative Court has just awarded young civil servants compensation for age-discriminatory pay because their pay violated the prohibition of age discrimination. The court derived the entitlement to compensation from § 15 para. 2 AGG (Federal Administrative Court rulings of 6.4.2017, 2 C 11.16 and 2 C 12.16). The pay regulations disadvantaged younger civil servants solely because of their age (ECJ ruling of 19.6.2014, C-501/12).

Discrimination: Employer's compensation completely tax-free

Who receives the inflation adjustment bonus?

If employers grant their employees an inflation bonus (inflation, inflation rate, rate of price increase), this is tax and social security-free up to an amount of 3,000 Euro. The condition for tax exemption is that the benefit is granted in addition to the salary already owed. The regulation applies to payments made between 26.10.2022 and 31.12.2024 (§ 3 No. 11c EStG).

Naturally, new regulations often raise questions, such as whether the payment of an inflation bonus is mandatory for employers. And, if it is paid, whether employers must distribute it equally to all employees of the company. The answer to the first question is "No, there is no obligation". The second question was answered by Parliamentary State Secretary Katja Hessel following an inquiry by Member of Parliament Fritz Güntzler (CDU/CSU) as follows:

"The tax exemption for the inflation bonus decided with § 3 No. 11 EStG does not include a regulation that the bonus must be paid to all employees. It is also a tax allowance that can be paid to employees in instalments within the benefit period" (Bundestag document 20/3987 of 14.10.2022).

Even though both the basic payment of the inflation bonus and any distribution among employees are at the employer's discretion for tax purposes, different practices may arise from collective or employment law. Employers may not arbitrarily favour certain employees or disadvantage others. If not all employees receive a bonus or if it is paid in varying amounts, there must be objective reasons for the different treatment. Otherwise, the principle of equal treatment applies under employment law.

Information on the inflation bonus can be found in the official Q&A catalogue of the Federal Ministry of Finance.

Who receives the inflation adjustment bonus?

Are there no more employment tax cards?

No. Since 2010, no new income tax cards have been sent out, as the government decided to switch to an electronic income tax procedure. This is intended to simplify communication between citizens and the tax office.

Since 2013, all the data that employers need for the monthly income tax deduction, which was previously on the cardboard income tax card, has been made available in a tax administration database for employers to access. This data is referred to as Electronic Income Tax Deduction Features (ELStAM):

• Income tax class,
• Factor for tax class IV,
• Marital status,
• Religion,
• Spouse's religion,
• Number of child allowances,
• Allowance for disabled persons / bereaved,
• Income tax allowance (for high work-related expenses, special expenses and extraordinary burdens),
• Exemption and addition amounts for low earners.

Are there no more employment tax cards?

What is the electronic employment tax statement and how do I obtain it?

An employment tax statement is provided to you by your employer at the end of the year. It is usually given to you along with the first payslip in January or February.

If you have not received the employment tax statement, request it from your employer. You do not need to include this statement with your tax return, as the data has already been electronically transferred to the tax authorities, as noted at the top of your employment tax statement.

If your employer processes payroll for their employees electronically, they must issue an electronic employment tax statement. However, they must send the data directly to the tax authorities. The employment tax statement contains your electronic wage tax deduction details, which were relevant for the monthly wage tax deduction.

What is the electronic employment tax statement and how do I obtain it?

How do I enter income tax statements from one or more employers?

If you have multiple employers, for example with a part-time job, you will also have received multiple statements. In this case, click on “Enter details of another payslip”. You can then enter the name of another employer in the newly appearing input form. This way, different jobs remain clearly organised in your tax return.

You can also remove a job from your tax return completely by clicking on the bin icon to the right of the employer's name.

If the employer taxes the mini job at a flat rate, you do not need to enter the income in the tax return. In this case, however, you cannot claim any work-related expenses or the employee allowance for your part-time job.

If it is a mini job for which you have given your employer permission for income tax deduction or released your electronic income tax deduction features (ELStAM), you must also enter the data in the income tax return.

How do I enter income tax statements from one or more employers?

What is a pension?

According to the definition in sect. 229 of the Social Code Book V (SGB V), pension benefits are income comparable to pensions (pension payments), insofar as they are earned due to a reduction in earning capacity or for old-age or survivors' pensions.

Pension benefits include:

• Pensions from insurance and pension institutions established for members of certain professions (e.g., doctors, architects, lawyers),
• Pensions of the company pension scheme including the supplementary pension in the civil service and the supplementary pension of the miners,
• Remuneration from the pensions of deputies, parliamentary state secretaries and ministers,
• Pension payments from a public-law employment relationship or from an employment relationship with entitlement to pension payments in accordance with civil service regulations or principles.

What is a pension?

What are remunerations for multi-year work?

A payment or advance payment for multi-year employment (e.g. severance payments) can be taxed at a reduced rate in the year of payment using the five-year method. The key factor is that the employment spans two calendar years.

The so-called five-year rule benefits extraordinary income under German tax law (§ 34 EStG). These so-called "income subject to preferential tax rates" are income earned over several years but realised and taxed in a single year.

What are remunerations for multi-year work?

Are my pension payments taxable?

Pension payments (retirement pay, widow's pension, orphan's pension, maintenance payments or similar) are considered income from employment under the Income Tax Act and are subject to the wage tax deduction procedure upon payment.

Since 2013, instead of the wage tax card, the pension office can electronically retrieve your wage tax deduction details from a tax administration database using your tax identification number and date of birth via ELSTAM (Electronic Wage Tax Deduction Features).

The taxation of pension payments is generally the same as that of salaries. The only difference is that an additional pension allowance is granted.

Since 01.01.2005, the taxation of retirement income (pension payments and annuities) has been re-regulated by the Retirement Income Act – AltEinkG. The core element of the Retirement Income Act is the transition from the taxation of contributions paid into retirement provision during the working phase ("upstream" taxation) to the taxation of benefits during the payout phase ("downstream" taxation). This is being implemented gradually during the transition period up to 2040; thereafter, civil service pensions and annuities will be treated equally for tax purposes.

The previously granted pension allowance is reduced annually, i.e. the later the pension begins, the lower the allowance until no pension allowance is granted for pensions starting from 2040. The flat-rate allowance for income-related expenses is 102 Euro, as with pension income.

The decisive factor for the amount of the (lifetime) allowance and the supplementary bonus to the pension allowance is the year the pension begins. The relevant percentage, the maximum amount of the pension allowance and the bonus to the pension allowance can be found in the table mentioned in § 19 para. 2 Income Tax Act (EStG).

The pension allowance and the bonus to the pension allowance apply for the entire duration of the pension payments. Regular adjustments to the pension payments do not lead to a recalculation.

However, a recalculation must be made if the pension payments increase or decrease due to the application of credit, suspension, increase, or reduction regulations. In the calendar year of the change, the highest pension allowance and bonus to the pension allowance apply.

Are my pension payments taxable?

When is severance pay taxed according to the one-fifth rule?

In the event of early termination of employment, the employees concerned are generally given a severance payment. Unfortunately, such payments have not benefited from a tax allowance since 2006, but they are still eligible for the one-fifth rule (in accordance with § 34 EStG).

To benefit from the reduced taxation under the one-fifth rule, the severance payment must be paid in a lump sum in one year, and the annual income with the severance payment must be higher than the income if the employment had continued uninterrupted. The tax concession is intended to mitigate the progressive effect of the income tax rate.

Currently, the Federal Fiscal Court has ruled that if the gross salary in the previous year was around 140,000 Euro, a severance payment of "only" 43,000 Euro cannot be taxed at a reduced rate. Therefore, the one-fifth rule does not apply. This is because when comparing the income from the previous year with the income in the year of the severance payment, there is no higher income, no progressive effect, and therefore no tax disadvantage that needs to be offset (BFH ruling of 8.4.2014, IX R 33/13).

As part of the comparative calculation, two figures must be compared: the "actual figure", i.e. what you received in the relevant year including the severance payment, and the "target figure", namely the income you would have received if the employment had continued uninterrupted. You can use the previous year's income as a basis. If the severance payment does not exceed the income lost by the end of the year, you can include other income that you would not otherwise have received, such as unemployment benefit.

When is severance pay taxed according to the one-fifth rule?

Voluntary resignation: Is the severance payment subject to the one-fifth rule?

The early termination of employment by the employer is usually painful for the employee concerned. To ensure an amicable separation, the employee is often given a golden handshake. Compensation is provided for the loss of employment, which is also taken into account with tax benefits. But does this also apply if you resign yourself?

The severance payment is compensation within the meaning of § 24 No. 1a EStG and is therefore considered "extraordinary income". There is a tax benefit for this extraordinary income: the reduced taxation according to the so-called one-fifth rule (§ 34 EStG). However, this requires, among other things, that it is a "special event". This is assumed if the termination or amendment of the contract is initiated by the employer or if the employee acted under significant legal, economic, or factual pressure or at least in a conflict situation to avoid disputes when concluding a termination agreement.

Note: The tax benefit is not granted if you initiated the termination of the contract yourself, i.e., resigned without any prompting from the employer.

Currently, however, the Münster Finance Court has ruled in a case that a severance payment is also eligible for tax relief under the one-fifth rule according to § 34 para. 2 EStG if the employee concluded the termination agreement on their own initiative. In this case, the employee was under the significant factual pressure required by the BFH case law when concluding the termination agreement, as they acted in a conflict situation to avoid disputes about the continuation of the employment relationship and the promotion they sought (FG Münster of 17.3.2017, 1 K 3037/14 E, Revision IX R 16/17).

According to the finance judges, it is harmless for the tax benefit that the employee approached the employer and demanded the conclusion of a termination agreement with severance pay. For the assumption of a conflict situation, it is sufficient that there was an opposing interest between the employer and the employee, both parties contributed to the conflict, and the parties resolved the conflict by consensus.

These conditions were met because both parties resolved their conflicts of interest regarding early departure from service and promotion through the termination agreement.

Currently, the BFH has shared this view and dismissed the tax authorities' appeal. It follows that if an employer pays an employee a severance payment as part of the (amicable) termination of employment, actual findings on whether the employee was under actual pressure are usually unnecessary (BFH judgment of 13.03.2018, IX R 16/17, BStBl 2018 II p. 709):

If a severance payment is paid in different years, the tax reduction is forfeited, as ruled by the Federal Fiscal Court (BFH judgment of 6.12.2021, IX R 10/21).

The case: An employee received a severance payment in 2015 and a starting bonus in 2016 after losing their job. The tax office refused the tax reduction, which the BFH confirmed.

Reason: The one-fifth rule applies even if a main payment is made in one year and a partial payment in another year. The rule does not apply if the payments are compensation for the same event and there is no lump-sum payment.

Tip: Company agreements can be complex, especially with different benefits. Sprint bonuses, which are intended to motivate employees to terminate their employment early, are considered compensation and may be subject to the one-fifth rule (Hessian FG, court order of 31.5.2021, 10 K 1597/20).

Voluntary resignation: Is the severance payment subject to the one-fifth rule?