A severance payment is part of your taxable income in the year of receipt — but Germany offers a specific tax break for one-time compensation payments that can substantially reduce the bill. This is the Fünftelregelung (one-fifth rule) under § 34(1) EStG.
The basic principle
Severance counts as taxable income in the year it is paid. Without any special treatment, the entire amount would be added to your ordinary income for the year, potentially pushing you into a much higher marginal bracket. The Fünftelregelung mitigates this.
The Fünftelregelung in plain terms
The tax office calculates the additional tax that would arise on one-fifth of the severance amount, then multiplies that additional tax by five. The result is the tax on the entire severance. The effect is that the rate is calibrated as though the severance were spread over five years rather than received in one year — which lowers the marginal-rate hit substantially for taxpayers who would otherwise jump several brackets.
The benefit is largest when your ordinary annual income is well below the top bracket. For high earners already in the 42% / 45% range, the relief is small or zero.
Conditions for the Fünftelregelung
- The payment must be a compensation for loss of income (Entschädigung) and not a deferred ordinary salary.
- It must be received in a single tax year (the Zusammenballung principle). If the employer pays half in December and half in January, the rule may be denied unless the split was for genuine business reasons.
- The total of all severance-and-replacement income in the year must exceed what you would have earned by simply continuing employment, otherwise the “compensation for lost income” character fails.
What is NOT covered
- Notice-period wages (Annahmeverzugslohn) — these are ordinary salary and taxed normally.
- Vacation payout (Urlaubsabgeltung) — ordinary salary too.
- Bonus payments that fell due during the dispute period.
- Outplacement support paid in kind — generally a tax-free benefit, but rules vary.
A well-drafted settlement will separate these items from the severance amount so the Fünftelregelung applies only to the part the law treats as compensation.
Social security
Good news: severance is generally not subject to social-security contributions (no Krankenversicherung, Rentenversicherung, etc.) provided it is a genuine severance and not disguised salary.
Practical advice
We are not tax advisers, but we coordinate closely with your tax adviser (Steuerberater) on the optimal structure and timing of the severance — when there is room to do so. The most common levers are payment timing (deferring across tax years can sometimes worsen the position, contrary to intuition, because the Fünftelregelung needs Zusammenballung), splitting between severance and a continuing-payment component, and using a Steuerberater filing to claim the rule on the annual return.
When the Fünftelregelung actually helps (and when it doesn’t)
The relief is largest for taxpayers whose ordinary annual income is below the top tax brackets — typically up to around €60,000–€70,000 annual gross. For very high earners whose income already sits in the 42% or 45% bracket, the relief is small (because the marginal rate is already at the ceiling). For very low earners (below the tax-free allowance), the relief is also limited because there is little marginal-rate effect to spread.
Timing tricks that backfire
It can be tempting to “spread” the severance across two tax years to reduce the burden. This usually removes the Fünftelregelung benefit because the rule requires Zusammenballung — concentration in a single tax year. The exception is if a small “supplementary” payment is made in a later year for administrative reasons. Coordinate with your Steuerberater before agreeing to a payment schedule.
Social security and severance
Severance is generally not subject to social-security contributions (Krankenversicherung, Pflegeversicherung, Rentenversicherung, Arbeitslosenversicherung) provided it is a genuine compensation payment and not disguised continuing salary. If the agreement labels part of the payment as “back-pay” or “bonus”, that part is subject to social-security contributions.