Anyone who receives a severance payment must pay tax on it, but in most cases no social security contributions are due in return. This article summarizes what employers and employees should know about taxes on severance pay.
What employers should consider when making a severance payment
As part of the wage tax deduction procedure, employers are obliged to withhold a portion of the severance payment and pay it as wage tax for the taxable employees. If they withhold too small an amount, employers are liable for the employees' tax liability in case of doubt. Employers can in turn claim the severance payment as a business expense.
Apply the fifths rule correctly
The tax authorities offer employees a tax saving in accordance with Section 34 EStG, namely the so-called fifth rule. The application of the fifth rule means that the severance payment is spread evenly over five years when calculating the tax.
The calculation is as follows:
| Income (after income-related expenses etc.) | 50,000 euros |
| + one fifth of the severance payment | 4,000 euros |
| = Taxable income | 54,000 euros |
| Income tax payable thereon (2020) | 14,285 Euro |
| Taxable income without severance pay | 50,000 euros |
| Income tax payable thereon (2020) | 12,636 Euro |
| Income tax with severance pay | 14,285 Euro |
| - Income tax without severance pay | 12,636 Euro |
| = Difference | 1,649 Euro |
| five times the amount thereof | 8,245 Euro |
| Tax on severance pay with one-fifth rule | 8,245 Euro |
| Tax on severance pay without fifth rule | 8,369 Euro (= 21,0051* - 12,636) |
| Income tax savings | 124 Euro |
| Savings on solidarity surcharge (5.5 %) | 6,82 Euro |
| Savings on church tax (9 %) | 11,16 Euro |
| Total tax savings | 141,98 Euro |
*This amount corresponds to the income tax payable on a full taxable amount of EUR 50,000 + EUR 20,000 severance payment = EUR 70,000].
In principle, the greater the difference between the severance payment and the regular salary, the greater the tax savings.
Severance payment in installments makes sense?
According to the established case law of the Federal Fiscal Court, the application of the one-fifth rule requires that the severance payment is received in a single assessment period (i.e. in the same calendar year). An accumulation of income is always to be assumed if employees receive more in total with the severance payment in the respective calendar year than they would have received if they had continued their original employment relationship.
The receipt of several partial amounts in different assessment periods is generally detrimental, unless it is a minor payment in relation to the main payment that is received in a different assessment period. For reasons of simplification, the tax authorities do not object to assuming a minor payment if it does not amount to more than 10% of the main payment. It may therefore also be possible and sensible to split the severance payment over two years if one installment does not represent more than 10% of the total severance payment.
Severance pay is generally exempt from social security contributions
Furthermore, social security contributions are not payable in many cases. This applies to all areas of social insurance law, i.e. pension, health, long-term care and unemployment insurance. As an exception, social security contributions must be paid again for those who are voluntarily insured in the statutory health insurance scheme. They must pay health and long-term care insurance contributions as soon as they receive a severance payment.
Legal fees are advertising costs
Legal fees incurred (e.g. for negotiating a severance payment) can be taken into account as income-related expenses in the tax return, which can then also lead to tax savings.
