The One-Fifth Rule in Germany: How to Reduce Taxes on Severance Pay

Severance payments after job loss are subject to a the general, super-high tax rates in Germany. Also, the full amount is taxable for income tax — and often for solidarity surcharge and, if applicable, church tax, as well. As a result, up to half of the severance can end up with the tax office. While no social security contributions are due, the tax impact alone can come as a shock. And the options for reducing the tax burden for employees in Germany are limited. But lowering your tax rate is not impossible: For instance, the so-called one-fifth rule (Fünftelregelung can help reduce the tax leakage – at least a bit. Under the one-fifth rule, the tax man will pretend to spread the tax of a severance payment over five years, helping to reduce your effective income tax rate and hence increasing your net payout. This article explains what the one-fifth rule in Germany is, how it works, when it can be applied, and what employees and expats should keep in mind when negotiating severance pay.

1. What Is the One-Fifth Rule?

The one-fifth rule is a tax relief regulation under Section 34 of the German Income Tax Act (EStG). It is designed to prevent excessive tax burdens when employees receive large one-off payments, such as severance pay.

Instead of taxing the entire amount at once, the rule simulates spreading the payment over five years—resulting in a lower marginal tax rate.

✅ Key purpose:

• Reduce the progressive taxation effect of a large lump sum
• Keep more of your severance pay in your pocket

📌 The rule does not spread the payment or income tax over five years—it’s just a calculation method.

2. How Does the One-Fifth Rule Work?

Let’s break it down with a simplified example.

Assume:

• Annual salary: €60,000
• Severance pay: €30,000
• Total income without severance: €60,000
• Total income with severance: €90,000

Without tax relief, the €30,000 severance could push you into a much higher tax bracket.

How the One-Fifth Rule calculates tax:

1. Add 1/5 of the severance (€6,000) to your regular income (€60,000) → simulate a total of €66,000
2. Calculate the additional tax burden on that extra €6,000
3. Multiply that amount by 5 to determine the tax on the severance

💡 This method generally leads to a lower tax bill than if the full €30,000 were added all at once.

3. Requirements to Apply the One-Fifth Rule

To use the one-fifth rule, the following conditions must be met:

✅ The severance must be a one-time extraordinary income
✅ It must be compensation for losing your job (Entschädigung für entgangene Einnahmen)
✅ It must be paid in a single lump sum
✅ You must be tax resident in Germany at the time of payment
✅ No salary continuation or split payment across multiple years

📌 If your severance is paid over several months or after retirement, you may lose eligibility for the rule.

4. When Is the One-Fifth Rule Most Effective?

The tax relief is most effective when:

• Your severance is relatively large
• You had a high salary in the termination year
• You expect a lower income in the following year
• You avoid other one-time taxable events (e.g. selling property or receiving bonuses)

📌 The higher your regular income, the more likely you are to benefit significantly from this rule.

5. Can You Request the One-Fifth Rule Automatically?

The one-fifth rule is applied by the tax office (Finanzamt) when you:

• File your annual income tax return
• Properly declare your severance as extraordinary income (außerordentliche Einkünfte)
• Attach the relevant payslip or termination agreement

📌 However, employers do not apply the rule during wage tax withholding (Lohnsteuerabzug)—you must claim it later through your tax return.

6. What if the Rule Is Not Applied?

If the tax office overlooks or denies the one-fifth rule:

• File an objection (Einspruch) within one month of your tax assessment notice
• Submit supporting documents (e.g. severance agreement, employer letter)
• Consult a tax advisor to structure your return properly

💡 A tax advisor can also simulate both scenarios (with and without the rule) to ensure you get the best result.

7. Tax Saving Example: With vs. Without the One-Fifth Rule

Let’s take a real-world calculation based on the 2024 German tax formula.

📌 In some cases (with higher severance or lower income), savings can be several thousand euros.

8. What Expats Should Know

If you’re an expat working in Germany:

• You are eligible for the one-fifth rule if you are a tax resident
• If you leave Germany after termination, the timing of the severance is key
• Severance paid after you deregister or move abroad may be taxed differently or not eligible
• Check double taxation treaties (DTA) with your home country

📌 Consult a cross-border tax advisor before negotiating or finalizing your termination.

9. Checklist: How to Maximize the One-Fifth Rule

✅ Negotiate a lump-sum severance
✅ Avoid splitting payments across multiple years
✅ Avoid other one-off income (e.g. bonuses, stock sales)
✅ Consider delaying payment into a low-income year
✅ Confirm extraordinary income status in writing
✅ Include all documents in your tax return