Tax Advice on Severance Pay in Germany: One-Fifth Method & Co.
Severance pay advice: Tax structuring of compensation
In Germany, severance payments following the termination of an employment relationship can benefit from the so-called one-fifth method under certain conditions. Read here how the one-fifth method works, what conditions must be met and how it affects the taxation of your severance payment or extraordinary income.
What is the one-fifth method?
The one-fifth method (Fünftelregelung, 1/5-tel Regelung) is a special way of saving tax on severance pay or extraordinary income.
In Germany, a progressive tax rate applies, which means that the tax rates increase as taxable income rises, up to a maximum rate of 42 or 45 percent.
A severance payment made in the course of a calendar year is subject to the highest tax rate. However, the legislator has introduced the one-fifth method to reduce this tax burden. Here, the one-off severance payment is spread over a period of five years for tax purposes.
First, the severance payment is included in the calculation of taxable income as income from employment. Then the severance payment is deducted from the taxable income and divided by five. A fifth is then added back to the taxable income, the tax for this fifth is calculated and the calculated tax amount is then multiplied by five.
The application of the one-fifth method often results in substantial tax refunds, especially if other current income (including all sources of income except severance pay) and income-related benefits (such as unemployment benefits) are significantly reduced or deferred to future years.
What are the conditions for applying the one-fifth method?
The two most important requirements are
- Payment of the severance payment in one calendar year
- An accumulation of income
The one-fifth method can only be applied to one-off income. This means that it is primarily relevant for severance payments, redundancy payments and similar payments.
This includes severance payments after termination of employment, but also the following other income, for example:
- Back pay for previous years due to ineffective dismissal
- Back payment of pensions
- One-off capital payment from e.g. a direct commitment
- Allowance due to an employee's service anniversary
- Profit from the exercise of stock options
We will be happy to explain to you individually how the one-fifth method is calculated for your specific case. We will check for you on a case-by-case basis whether it is possible to apply this type of tax relief in your personal case.
Your tax advisor for severance payments in Germany and the one-fifth method
Are you about to receive a severance payment? Would you like to ensure that the tax burden on your severance payment is as low as possible? Our team is at your disposal with its experience!
We will be happy to assist you with all questions relating to severance pay. The easiest way to contact us is at info@winheller.com or by phone on +49 69 76 75 77 85 21.
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