Income Tax on Severance Pay in Germany: What You Need to Know

Severance pay (Abfindung) can be a financial lifeline when your employment ends—whether due to layoffs, mutual termination agreements, or court settlements. But many employees are surprised to learn that severance payments are subject to income tax in Germany. Understanding how income tax on severance pay in Germany works is crucial to making informed decisions during termination negotiations and avoiding unpleasant surprises at tax time. This article explains how severance payments are taxed, how to reduce your tax burden legally, and what expats and international employees should consider when receiving compensation at the end of an employment contract.

1. Is Severance Pay Taxable in Germany?

Yes. Severance pay is generally considered taxable income under German law.

This means:

• Severance is subject to income tax (Einkommensteuer)
• It is not subject to social security contributions (no health, pension, unemployment, or long-term care deductions)
• It must be declared in your annual tax return

📌 There are no special exemptions that make severance payments tax-free—but you can potentially benefit from tax relief mechanisms.

---

2. How Is Severance Taxed?

Severance pay is added to your annual taxable income, which can push you into a higher tax bracket—especially if it’s a large one-time payment.

The result:

• You may pay a significantly higher tax rate on the severance
• The overall tax burden increases even if the amount is “one-off”

To reduce this effect, German tax law allows for the “Fünftelregelung”.

---

3. What Is the “Fünftelregelung” (One-Fifth Rule)?

The Fünftelregelung is a tax relief method designed to spread the tax burden of severance over multiple years.

Here’s how it works:

• The severance is theoretically divided into five equal parts
• The tax is calculated as if one fifth of the severance were added to your regular income
• The difference in tax is then multiplied by five and added to your total tax due

💡 This method can significantly lower your effective tax rate—especially if you had high earnings in your final working year.

📌 The calculation is done automatically by the tax office if the requirements are met.

4. Requirements for the One-Fifth Rule

The Fünftelregelung can only be applied if:

✅ The severance is paid as a lump sum
✅ The payment is compensating for job loss
✅ It is extraordinary income under § 34 EStG
✅ The severance is not split over several years or months
✅ You were not already retired when receiving the payment

📌 If your severance is split into monthly payments or delayed installments, you may lose the right to use the one-fifth rule.

---

5. Example Calculation: Without and With One-Fifth Rule

Let’s assume:

• Annual salary: €60,000
• Severance: €30,000

Without One-Fifth Rule:

Tax is calculated on €90,000 → pushes income into a higher bracket → higher tax burden

With One-Fifth Rule:

Tax is calculated on €60,000 + €6,000 → difference multiplied by 5
Results in lower marginal tax rate on the severance portion

💡 Depending on your income level, you could save thousands of euros in taxes with this method.

6. Important Tax Tips for Severance Recipients

• Negotiate lump-sum payment in the same calendar year
• Avoid other large payments (bonuses, dividends) that year
• If possible, delay payment to a year with lower income (e.g., unemployment)
• Speak with a tax advisor before signing a termination agreement
• Consider applying for wage tax deduction adjustment (Lohnsteuerermäßigung) in advance

📌 Many employees lose tax savings opportunities simply because of poor timing or structuring of the severance agreement.

---

7. Special Considerations for Expats

If you are an international employee or expat:

• Severance pay received while residing in Germany is generally taxable in Germany, even if the work was performed abroad
• If you move abroad after termination, timing is critical for tax residency
• If you’re a tax resident of another country, double taxation agreements (DTA) may apply
• Always consult a cross-border tax advisor if you plan to leave Germany or are unsure about your tax status

---

8. Can Severance Be Paid Tax-Free?

There is no legal way to receive severance completely tax-free in Germany. However, tax-optimized structuring and use of the Fünftelregelung can substantially reduce your liability.

In rare cases:

• Severance may be recharacterized (e.g. compensation for damages)
• Outplacement services or training budgets may be agreed tax-free
• Certain compensation for discrimination or emotional distress may fall outside tax scope (case-dependent)

---

9. Declaring Severance Pay in Your Tax Return

You must declare your severance payment in your income tax return (Einkommensteuererklärung) for the year in which it was received.

• It will be listed on your Lohnsteuerbescheinigung under “Other Payments”
• The tax office will automatically check whether the Fünftelregelung applies
• You can request it explicitly under “Sonstige Einkünfte” (Other income)

📌 If the employer misreports or splits the payment incorrectly, you may lose the tax benefit.

---

Conclusion

Receiving severance pay in Germany is often a welcome cushion after termination—but understanding the income tax on severance pay is crucial to keeping as much of that payout as possible.

With proper planning and the one-fifth rule, you can minimize your tax burden and avoid unpleasant surprises. Whether you’re a German employee or an expat facing job loss, be sure to consult with a tax advisor and negotiate your severance carefully to make the most of your rights.