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 amicably terminated. 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).

(2022): Discrimination: Employer's compensation completely tax-free

Save with a tax allowance in the ELStAM!

If you have high income-related expenses, special expenses, or losses from other types of income (e.g. rental income, business operations, capital assets, etc.), you pay too much income tax from your salary every month.

Only when you complete your income tax return can you reclaim the overpaid income tax from the tax office.

With an application for income tax reduction, you can have the tax office enter an allowance for various tax deductions and your anticipated expenses in the electronic income tax deduction features (ELStAM). During payroll processing, your employer will then reduce your gross salary by the monthly allowance. As a result, income tax is calculated only on the reduced gross salary. This way, you pay less tax during the year with an allowance, as well as less solidarity surcharge and church tax.

(2022): Save with a tax allowance in the ELStAM!

How can I have the child allowance entered in the ELStAM?

The child allowance is granted retrospectively, but you can have it entered in your electronic payslip deduction details (ELStAM). Although you will not pay less income tax in advance, the mid-year burden may still decrease. This is because the child allowance is taken into account when calculating church tax and the solidarity surcharge, which are then reduced. You must have the allowance entered at your tax office. You should bring the following documents:

• Identity card or passport
• Payslip
• Birth certificate
• If applicable, paternity recognition certificate if you are not married
• If applicable, certificate of life for children registered at a different address

The certificate of life must not be older than three years. If you cannot provide the certificate of life, e.g. because the child lives abroad, you must contact your tax office. The tax officer will enter the child allowance there.

Parents of children over 18 must also contact the tax office to have allowances entered.

(2022): How can I have the child allowance entered in the ELStAM?

How do I have allowances or changes entered in the ELStAM?

Taxpayers who wish to enter an allowance in their electronic payslip deduction details (ELStAM) should contact the tax office. If you want to have an income tax allowance for high work-related expenses taken into account, you can submit a corresponding application. The same applies to application-based deduction features, such as the consideration of adult children, foster children, tax class II for single parents.

Even if you have already used such an allowance in the previous year and the circumstances have not changed significantly, a new application for the new year is required. Only an already entered disability allowance will continue to be taken into account without a new application. The same applies if the disability allowance for a child has been transferred to the parents.

If the stored ELStAM are not correct, you must apply for a correction at the relevant local tax office. To do this, use the form "Correction application for electronic payslip deduction details", which you can obtain from the tax office or online.

Since 1 January 2016, the income tax allowance is generally valid for two years. If your circumstances change in your favour within the two years, you can have the allowance changed at the tax office. However, if your circumstances change to your disadvantage, you are obliged to have the allowance changed. A change may occur, for example, if you change employer, if the distance to your place of work or employment increases or decreases significantly, or if double housekeeping is established or discontinued (§ 39a para. 1 sentences 4-5 EStG).

(2022): How do I have allowances or changes entered in the ELStAM?

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 the 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.

(2022): Who receives the inflation adjustment bonus?

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 tax-privileged under the one-fifth rule in accordance with § 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 payment. 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, factual findings on whether the employee was under actual pressure are generally unnecessary (BFH ruling of 13.03.2018, IX R 16/17, BStBl 2018 II p. 709).

(2022): Voluntary resignation: Is the severance payment subject to the one-fifth rule?

How much is the church tax?

The amount of church tax depends on your place of residence. If you live in Bavaria or Baden-Württemberg, church members pay 8 percent; in other states, it is 9 percent. The basis is the assessed income tax. You therefore pay 8 or 9 percent of your income tax as church tax.

Please note: The church tax is also taken into account at the same percentage rate within the withholding tax. If you have children or if your taxable income (zvE) includes income from business operations and/or income taxed under the so-called partial income procedure, the zvE for church tax purposes is calculated separately. If child allowances are entered in employees' electronic wage tax deduction features (ELStAM), the monthly church tax is calculated based on a so-called fictitious wage tax.

Church tax without child allowance: You live in Berlin and have a gross monthly salary of 3.000 Euro in tax class IV. Your monthly church tax is 37.11 Euro.

Church tax with two child allowances: You live in Berlin and have a gross monthly salary of 3.000 Euro in tax class IV. Your monthly church tax is now 20.39 Euro.

If a "number of child allowances" is entered in the ELStAM (Electronic Wage Tax Deduction Features), the monthly wage tax is not reduced, only the monthly church tax and the monthly solidarity surcharge. This also applies if you receive child benefit during the year.

In the income tax assessment, child allowances only reduce the taxable income if the child benefit is not more favourable than the tax advantage. However, for the calculation of church tax and solidarity surcharge, the child allowances are deducted "fictitiously".

Advantage: Even if children are only to be considered for part of the year, the full child allowance and BEA allowance are always deducted for the calculation of church tax and solidarity surcharge. This applies in the case of the end of vocational training or the birth of a child.

(2022): How much is the church tax?

How are short-time work benefits and maternity pay taxed?

Short-time work allowance and maternity pay are not taxed, but they are subject to the progression clause. This means that receiving short-time work payments can negatively affect the employee in the tax assessment. The progression clause means that tax-free wage replacement benefits are added to the taxable income. A special tax rate is calculated for this amount, and this special rate is then applied to the taxable income - excluding the wage replacement benefits.

How do wage replacement benefits increase my tax rate?
Wage replacement benefits such as short-time work allowance or maternity pay supplement are paid to you tax-free. However, these benefits are subject to the progression clause. This means that the tax-free income is added to your income to determine your personal tax rate. Due to the now higher income, a higher tax rate is applied to your remaining income. This means you may have to pay additional taxes or receive a lower refund than in the previous year without the wage replacement benefit.

A single mother has an annual income of 26.000 Euro gross. She also receives 6.000 Euro parental allowance, making a total income of 32.000 Euro. The income tax for this would be around 5.706 Euro, which corresponds to a tax rate of 17.83 percent. However, this tax rate is only applied to the income without parental allowance, so the tax is 4.636 Euro.

Without the progression clause, the tax on an income of 26.000 Euro would only be 3.911 Euro. This means that for the actually tax-free parental allowance of 6.000 Euro, 725 Euro more in taxes must be paid. Additionally, church tax and (for high incomes) the solidarity surcharge may increase.

Without the progression clause, the tax on an income of 26.000 Euro would only be 3.911 Euro. This means that for the actually tax-free parental allowance of 6.000 Euro, 725 Euro more in taxes must be paid. Additionally, church tax and (for high incomes) the solidarity surcharge may increase.

In this way, income that falls below the basic allowance and is therefore actually tax-free is also taxed. If the actual income including wage replacement benefits exceeds the basic allowance, the increased tax rate can be applied. However, if the income remains below the basic allowance even with wage replacement benefits, it does not have to be taxed. If you only receive wage replacement income within a year, everything remains tax-free and the progression clause is not applied.

Tip: If you have to repay a wage replacement benefit later, for example because you previously received too much unemployment benefit, you should submit a tax return. This creates negative progression, as the repaid wage replacement benefit can reduce your tax rate. However, if you had no taxable income in the relevant year, it is not worth submitting the repaid wage replacement benefit, as this has no tax implications for you.

Tip: Many employers top up the short-time work allowance to 80, 90 or even 95 percent. So far, this top-up amount to the short-time work allowance is taxable as wages. In social security law, such supplements up to 80 percent of the last net salary are not considered wages and are therefore exempt from social security contributions (§ 1 Abs. 1 Nr. 8 SvEV).

Currently, employer supplements to short-time work allowance and seasonal short-time work allowance are tax-free due to the coronavirus, provided they do not exceed 80 percent of the difference between the target salary and the actual salary together with the short-time work allowance. This regulation is valid from 1.3.2020 to 30.06.2022. The tax exemption promotes the top-up of short-time work allowance by the employer, which is often agreed in collective agreements but also voluntarily due to the coronavirus crisis (§ 3 Nr. 28a EStG-neu).

The top-up amounts are subject to the progression clause, like the short-time work allowance itself, insofar as they are or were tax-free (§ 32b Abs. 1 Nr. 1 g EStG).

(2022): How are short-time work benefits and maternity pay taxed?

Are there wage replacement benefits that I won't find on my income tax statement?

Yes. Wage replacement benefits that you do not receive from your employer are also not shown on your income tax statement.

Wage or income replacement benefits include in particular:

• Unemployment benefit I,
• Short-time work allowance and seasonal short-time work allowance,
• Insolvency benefit in the event of employer insolvency,
• Parental allowance under the Federal Parental Allowance and Parental Leave Act,
• Maternity benefit, maternity benefit supplement,
• Sickness, injury, and transitional benefits for disabled persons or comparable wage replacement benefits,
• Top-up amounts and partial retirement bonuses under the Partial Retirement Act or civil service law,
• Wage subsidies for older employees from the employment agency.

(2022): Are there wage replacement benefits that I won't find on my income tax statement?

What can I deduct if my employer provides benefits for commuting to work?

Does your employer pay you a tax-free travel allowance for commuting? 

In principle: Such an employer's allowance is taxable, but the employer can tax it at a flat rate of 15% (for the new regulation of a flat rate tax of 25%, see the note below). The amount taxed at a flat rate is exempt from social security contributions. The employer must note the amount taxed at a flat rate on the payslip, and you must enter this amount as travel expense reimbursement in your tax return (Form N, reverse side).

The tax office will accordingly reduce the deductible travel expenses and only recognise the remaining travel expenses as business expenses. If your employer provides you with a job ticket for travel, this is a benefit in kind. If the employer's contribution does not exceed 50 Euro per month, this amount is tax and social security-free.

New since 2019:

Since 1 January 2019, employer benefits - allowances and job tickets - for employees are tax and social security-free under the following conditions for the following journeys:

• Journeys between home and first place of work,
• Journeys to a permanent collection point specified by the employer (e.g. fixed meeting point, specific car park, bus or train depot, ferry port),
• Journeys to a large-scale work area (e.g. forest area, port area, but not factory premises) in accordance with § 9 para. 1 no. 4a sentence 3 EStG.

(§ 3 no. 15 EStG 2019, introduced by the "Act to Avoid VAT Losses in the Trade of Goods on the Internet and to Amend Other Tax Regulations" of 11 December 2018).

Which means of transport are subsidised?

• Employer benefits for the above-mentioned journeys of the employee with public transport in scheduled services, i.e. long-distance passenger transport (1st alternative). This only applies to employees in active employment and to temporary agency workers employed by the hirer. Private journeys are not subsidised. Long-distance passenger transport (public transport in scheduled services) includes long-distance trains of Deutsche Bahn (ICE, IC, EC), long-distance buses on fixed routes or routes with fixed stops, comparable high-speed trains and fast long-distance trains of other providers (e.g. TGV, Thalys).
• Employer benefits for the above-mentioned journeys as well as for private journeys of the employee in local public transport (2nd alternative). This applies to all employees or temporary agency workers. The use of local public transport is subsidised regardless of the type of journey, i.e. also for private journeys of the employee. This means that - unlike in long-distance passenger transport - no further check on the type of use is required for travel authorisations that only allow the use of local transport. Local public transport includes the generally accessible transport of persons in scheduled services, which is mainly intended to meet the demand for transport in urban, suburban or regional traffic. For reasons of simplification, all public transport that is not long-distance passenger transport is considered local public transport. Insofar as taxis are used in scheduled services in accordance with the approved local transport plans (e.g. to increase, supplement or replace other public transport) and are included in the travel authorisation or may be used for a small surcharge, they are considered local transport.

Travel allowances for journeys with your own car are taxable from 2019, but the employer can tax them at a flat rate of 15%. The amount taxed at a flat rate is exempt from social security contributions (§ 40 para. 2 sentence 2 EStG). The travel allowance taxed at a flat rate does not increase the gross salary shown on the payslip. Only if the travel allowance is not taxed at a flat rate will it be added to the gross salary and taxed normally.

The flat rate taxation is only permissible if the allowance is paid in addition to the salary already owed and not if salary is converted into a travel allowance. However, it is often possible to pay travel allowances instead of a salary increase. 

The following means of transport are not subsidised:

• buses or trains rented or chartered for specific occasions,
• taxis in occasional services that do not operate on licensed routes,
• air transport.

Which employer benefits are subsidised?

The tax exemption includes

• employer benefits in the form of free or discounted travel authorisations (benefits in kind, job ticket),
• employer subsidies (cash wages) for travel authorisations purchased by employees themselves.

Subsidised travel authorisations include single/multiple journey tickets, season tickets (e.g. monthly, annual tickets, Bahncard 100), general free travel authorisations, free travel authorisations for certain days (e.g. in the event of smog alerts) or discount cards (e.g. Bahncard 25).

Price advantages from third-party companies and group companies (subsidies and benefits in kind) that are granted in consideration of the employment relationship and would be treated as wages are also tax-free (according to BMF letter of 20 January 2015, BStBl. 2015 I p. 143).

Price advantages granted to employees by third parties are part of taxable wages if they represent a benefit of the employee's work for the employer and are related to the employment relationship, or if the employer has actively participated in obtaining these price advantages.

Such price advantages are tax and social security-free if the third-party company has a predominantly self-economic interest in granting the discount, the third-party company also usually grants the price advantage to third parties in the normal course of business, e.g. quantity discounts, or the granting of the advantage is in the overwhelming interest of the employer.

The monetary benefit of a job ticket is no longer offset against the 50 Euro exemption limit for benefits in kind. This benefit can now be used elsewhere (§ 8 para. 2 sentence 11 EStG). For employees of transport companies, the tax-free free travel authorisation is no longer offset against the personal discount allowance of 1,080 Euro (§ 8 para. 3 EStG).

If you receive a subsidy from your employer for commuting with your own car, the previous regulation remains in place, i.e. the subsidy can be taxed by the employer at a flat rate of 15% (§ 40 para. 2 sentence 2 EStG).

Since 1 January 2019, the employer can choose another form of flat rate taxation for job tickets and subsidies that are not tax-free under § 3 no. 15 EStG:

Taxation at a flat rate of 25%, but without reducing the travel allowance (§ 40 para. 2 sentence 2 no. 2 EStG, amended by the "Act on Further Tax Promotion of Electric Mobility and Amendment of Other Tax Regulations" of 12 December 2019).

Sometimes this can be more favourable than taxation at 15%. However, which form is more advantageous depends on the individual case. The travel allowance only applies if it exceeds the employee allowance of 1,200 Euro per year (provided there are no other business expenses). For rather short distances, it may therefore make sense to choose the flat rate taxation of 15%, as in these cases the reduction of the travel allowance does not or hardly matters.

Do I also get the travel allowance if I use a company car?

You can also claim the travel allowance if you use a company car for commuting. However, you must observe the following special features: For journeys between home and work, you must tax a surcharge on the private use value. This amounts to 0.03% of the list price per kilometre of distance for journeys to work and is added to the private use value of 1% of the list price per month.

In return, you may then, like any other employee, claim the travel allowance of 0.30 Euro per kilometre of distance (0.38 Euro from the 21st kilometre) as business expenses. However, if your employer taxes the taxable use value for the company car at a flat rate of 15%, you must deduct the monthly amount taxed at a flat rate from your business expenses and can only claim the remainder as business expenses.

(2022): What can I deduct if my employer provides benefits for commuting to work?

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.

(2022): What is a pension?

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

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

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

(2022): Are my pension payments taxable?

Severance Pay: The Most Important Information on 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 to offset the loss of employment, which is also taken into account for tax purposes with tax benefits.

What amount of severance pay should be assumed?

According to Section 1a of the Employment Protection Act (KSchG), all employees are entitled to severance pay in the event of redundancy. A voluntary severance offer must be forwarded to the employee together with the notice of termination. However, the condition for receiving the severance pay is that the employee does not contest the dismissal. The amount of severance pay is based on the number of years of employment with the company.

There is usually an entitlement to half a month's salary for each year of employment. For ten years of service, there is an entitlement to an amount equivalent to five months' salary. Claims from benefits in kind provided by the employer are added. If a company car or laptop was provided, the value of use must be added to the calculation of the severance amount. Certainly, lower or higher severance payments are also possible, but these are usually not redundancy but rather a settlement or severance agreement.

Tax treatment of the one-fifth rule

Since the Tax Amendment Act 2001, the consideration of the one-fifth rule no longer needs to be applied for. The tax office automatically checks whether normal taxation or the reduced taxation according to the one-fifth rule is more favourable for you.

Important: If severance pay or remuneration for work over several years has been taxed by the employer according to the one-fifth rule, you are obliged 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 work over several years, 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 pay is divided by 5 and one-fifth is added to the remaining taxable income.
• Income tax is then calculated for the sum 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.

A married employee receives a severance payment of 50.000 Euro in the year 2022. The taxable income amounts to 70.000 Euro. The taxable income is increased by one-fifth of the severance payment (i.e. 10.000 Euro):

• Income tax (splitting rate) on 70.000: 13.024 Euro
• Income tax (splitting rate) on 80.000: 16.354 Euro
• Difference 3.330 Euro
• Income tax on the severance payment: (3.330 Euro x 5 =) 16.650 Euro
• Total income tax: (13.024 Euro + 16.650 Euro=) 29.674 Euro

Does the one-fifth rule also apply in the case of resignation?

In 2017, the Münster Finance Court ruled that severance pay is also eligible for tax relief under the one-fifth rule in accordance with Section 34 (2) EStG if the employee initiated the termination agreement. In the case in question, the employee was under significant actual pressure, as required by the BFH case law, when concluding the termination agreement, as he was acting in a conflict situation to avoid disputes about the continuation of the employment relationship and the promotion he sought (Münster Finance Court, 17.3.2017, 1 K 3037/14 E).

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

(2022): Severance Pay: The Most Important Information on the One-Fifth Rule

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 Fifth Rule (in accordance with § 34 EStG).

To benefit from the reduced taxation under the Fifth Rule, the severance payment must be made 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 with a gross salary of around 140,000 Euro in the previous year, a severance payment of "only" 43,000 Euro cannot be taxed at a reduced rate. Therefore, the 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.

(2022): When is severance pay taxed according to the one-fifth rule?

What are remunerations for multi-year employment?

A subsequent payment or advance payment for multi-year work (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 work spans two calendar years.

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

(2022): What are remunerations for multi-year employment?