One-Fifth Rule Severance: Save Taxes on Your Severance Payment

If you receive a severance payment in Germany, the one-fifth rule severance can significantly reduce the income tax you owe.

This provision spreads the severance over five years for tax purposes, lowering the progressive tax burden.

One-Fifth Rule Severance: What It Is and How It Works

The legal basis is § 34 EStG. It applies only to income tax; social security contributions remain unaffected because severance payments are contribution‑free in the statutory health, long‑term care, pension and unemployment insurance.

The one-fifth rule severance exists to offset the hardship that would arise if a lump‑sum payment were taxed all at once, which could push the recipient into a much higher tax bracket.

To benefit from the one-fifth rule severance, several conditions must be met simultaneously, as outlined below.

Requirements: When Does the One‑Fifth Rule Apply?

Not every payment made upon job loss automatically qualifies for the one‑fifth rule. Several conditions must be satisfied at the same time:

• Income concentration: The severance must lead to an accumulation of income in a calendar year. This is normally the case when, in addition to the severance, regular salary (e.g. pay up to the termination date, vacation compensation) is also received.
• One‑time payment: It must be a one‑off payment. Recurring benefits (e.g. a monthly pension from a pension compensation) do not qualify.
• Connection to termination of employment: The payment must be caused by the end of the employment relationship. Typical severances in the context of a settlement agreement, after a dismissal protection lawsuit or under § 1a KSchG meet this condition.
• No other tax‑advantaged treatment: If the payment is already privileged under other provisions (e.g. § 19 EStG for old‑age compensation), the one‑fifth rule does not apply.

If any of these requirements is missing, the severance is taxed as ordinary income under § 39b EStG – with a considerably higher tax burden.

How Is the Tax Calculated? A Sample Calculation for the One‑Fifth Rule and Severance

The calculation proceeds in three steps. Assume your taxable income without the severance is €45,000 (tax class 1, no children). You receive a severance of €60,000.

1. Step 1 – Tax without severance: On €45,000 (simplified) the income tax is about €8,500.
2. Step 2 – Tax with one‑fifth of the severance: One‑fifth of €60,000 equals €12,000. Added to €45,000 gives €57,000. Tax on that amount is roughly €12,200. The difference to step 1 is €3,700 – this is the tax on one‑fifth of the severance.
3. Step 3 – Quintupling: €3,700 × 5 = €18,500. This is the tax on the total severance under the one‑fifth rule.

For comparison: if the severance were taxed as regular income (total €105,000), the tax would be about €32,000. The saving thanks to the one‑fifth rule in this example is therefore roughly €13,500. The actual saving depends strongly on your personal tax rate and the size of the severance – the higher your marginal rate without the severance, the greater the effect.

One‑Fifth Rule versus Regular Taxation: The Practical Difference

In practice, the employer applies the one‑fifth rule during wage‑tax withholding when the conditions are met. You can see this on the income‑tax statement under the entry “one‑fifth rule” (field 19). The tax authority checks in the income‑tax assessment whether the conditions were actually fulfilled. If it finds that the concentration of income is missing (for example because you had no other income in the termination year), the tax is corrected afterwards – often to your disadvantage.

A common misconception is that the one‑fifth rule applies automatically to every severance. In fact, the tax authority examines the case closely. The timing of the payment is especially critical. If you receive the severance only in the following year (e.g. January instead of December), the concentration with the current year’s salary disappears – the one‑fifth rule may then be denied. In such cases it often makes sense to schedule the payout date deliberately in the settlement agreement.

Common Pitfalls and How to Avoid Them

From advisory practice, typical mistakes that can cost employees money are summarized below:

• Payout in the wrong calendar year: As described above, shifting the payment by just a few days can forfeit the benefit. Clarify the payment date in the contract.
• Waiving regular salary: If you give up wages, vacation pay or Christmas bonus to increase the severance, the income concentration may disappear – the one‑fifth rule no longer applies.
• Several severance payments in one year: If you receive, for example, a severance from your former employer and compensation from the new one (e.g. a signing bonus), the tax authority checks whether the income concentration still exists. Often the second payment is then taxed at the regular rate.
• Failing to file a tax return: Even if the employer applies the one‑fifth rule, you are obliged to file an income‑tax return (§ 46 EStG). Otherwise the tax authority may withdraw the benefit afterwards.

A look at our article severance pay after dismissal – your rights as an employee shows how important the contractual design already is before signing.

Special Considerations in Insolvency and Estate Insufficiency

A special case arises when the employer is insolvent and can pay the severance only partially or not at all. Often the insolvency benefit from the Federal Employment Agency steps in – but only for arrears of salary, not for severance. If the severance fails to materialize, the tax liability disappears as well. If it is paid later (e.g. after restructuring), the one‑fifth rule applies in the year of actual receipt. Those affected by major insolvencies can find further information in our article insolvency benefit, dismissal and severance at the AWO Bielefeld on this complex topic.

Checklist: Using the One‑Fifth Rule Optimally

If you are negotiating or have already been offered a severance, keep the following points in mind:

• Check with a tax adviser or specialist employment lawyer whether the one‑fifth rule applies in your case – before signing the settlement agreement.
• Set the payment date so that the income concentration with regular salary is secured in the same calendar year.
• Do not lightly waive salary components that create the income concentration.
• Keep all documents (termination letter, settlement agreement, calculations) for the tax return.
• File an income‑tax return for the year of receipt without fail.

The one‑fifth rule is a powerful tool, but it works only when the formal requirements are met. Early advice pays off almost always – both tax‑wise and financially.

Note: This article provides general information and does not substitute for tax or legal advice in individual cases. The calculations shown are simplified examples. For a free initial assessment of whether litigation funding is suitable for your case, you can contact RechtStark.

Note: This article is for general information purposes only and does not replace individual legal advice. For a free initial assessment of whether litigation funding may be an option for your case, you can contact RechtStark.