How to lower your tax burden on severance pay in Germany – 3 “tax traps” to avoid!
Do you have to pay tax on the severance pay after termination in Germany? Yes – employees have to pay income taxes on their severance pay. And generally “in full”, although the severance payment for the loss of a job is paid as a one-time payment and often a reimbursement for the loss of a long-time job. However, there are some small perks even in Germany, such as the “rule of one-fifth”. If a severance payment was paid out in full in one calendar year, you can achieve a (relatively small) tax reduction. The tax burden can also be optimized by structuring the timing of payments over several calendar years.
A small silver lining: Severance payments are generally exempt from social security contributions.
Why do you have to pay tax on a severance payment in Germany?
A severance package is usually paid as compensation for the loss of a job. It is therefore an “extraordinary payment”. Nevertheless, it has been fully taxable in Germany for several years. The severance payment is treated like normal salary. And this is despite the fact that the severance payment can lead to a significant increase in tax progression. However, there is a small tax concession with the so-called “fifth rule”. You can first carry out a rough check of the range of your possible severance payment here:
Good news: Even if you have to pay tax on the severance payment, in most cases there are no social security contributions (Section 14 SGB IV SGB). This applies to pension and health insurance as well as long-term care and unemployment insurance (there are exceptions for people with voluntary health insurance). The following explanations therefore deal exclusively with the taxation of a severance payment. Everything you need to know about negotiating compensation, for example, can be found in our article on severance pay in general.
If you (or will) receive a severance payment, you should watch out for the following three “tax traps”:
Tax Trap 1 – Not using the “one-fifth rule”
The so-called “one-fifth rule” reduces the tax burden because income tax rates in Germany are “progressive”. This means that as your income increases, so does the tax rate. If, for example, an employee is paid a high severance payment at the end of a long-term employment, the tax rate increases accordingly. Due to the so-called “fifth rule”, the severance payment in the tax calculation is spread over five years.
The employer deducts the wage tax and uses this form of wage tax calculation if it results in a lower wage tax. Those taxpayers with relatively low earnings and high severance pay have the greatest tax-saving effect.
However, the reduced tax rate on the severance payment is only possible if it was paid out in one amount. In many cases, it would be more tax-efficient if it were paid out in several installments. After all, the terminated employee has lower income to pay tax in the following years – e.g. because there is still no new job – and thus a lower assessment basis. However, this is not possible with the rule of fifths.
Tax Trap 2 – Poor payout timing
As an alternative to the fifth rule, taxpayers who can plan their income well can also reduce their tax burden by distributing the severance payment over time. In the case of payments over several years, the fifth rule does not usually apply. But if you can already foresee, for example when negotiating the severance payment in December 2021, that you will take a break in 2022, you can save taxes. In 2022 he would have lower earnings and a lower progression. If the payment is postponed to the following year, the severance payment will only then be taxed. Even a payment, e.g. on February 1, 2022 instead of December 31, 2021 can significantly reduce the tax burden. In principle, the timing of the allocation depends on the inflow time. However, this depends on the specific individual case (e.g. what other income is generated and what the overall tax burden is).
Tax trap 3 – Missed church tax waiver / exemption
Do you also have to pay tax on the severance payment for “church tax”? In Germany, yes, if you are a member of one of the churches. But there is a little-known “trick” to at least reduce this tax. As a rule, church members can reclaim half of the church tax paid on a severance payment. Because the severance payment is also treated as extraordinary income for church tax purposes. You can therefore submit an application with the aim of partially “waiving” the church tax. This usually works for most church members, although there is no legal entitlement to such a partial waiver. However, for decades church members have been “waived” up to 50% of the church tax on the in such cases. Pls note that the waiver has a countering effect of increasing income taxes, since the church tax is partly eliminated, which in turn is fully deductible as special expenses. However, the net effect is positive, albeit smaller than one would expect.
Attention: If you leave the church at the same time, the church tax decree is often denied (e.g. according to the decree of the Archdiocese of Berlin here). Therefore, always first “go through” with the application for decree – and only then leave the church.
In order to benefit from this benefit, you must submit an informal application for a partial waiver of church tax to the responsible church tax office. In Berlin, for example, this is the Archbishop’s Ordinariate. After the tax assessment has been announced, the application must be submitted with suitable documents for examination at the latest before the end of the assessment period (§ 169 AO).
Optimizing severance pay for tax purposes – what else can you do?
If you want to optimize your severance payment for tax purposes, you should seek advice on labor law and tax law. Our partner lawyers can also help you with your tax questions. Please feel free to contact us:
* A note about our wording. We do not always “gender” – E.g. when we are talking about employees. But we are trying to keep things simple. German labor law is complex enough. For the sake of clarity and legibility in our texts, we have therefore decided to omit most gender formulations.