Fünftelregelung: What is this and how a Severance Pay is Taxed

It is not a new phenomenon for employees to leave a company they were working for. People leave their places of work for different reasons. The reasons could be either that the location is closed, you want to reorient yourself, the company is bankrupt or you just simply will not need it anymore.

Especially in the case of the latter, a worker often wins a hefty compensation. However, one should not be blinded by the supposedly high sum, because of course, the Treasury also wants to get a piece of the cake. After all, with the fifth rule, a little more is left in the wallet. In this article, we will be focused on showing you how a compensation is taxed.

Tax severance pay: what's that? (Abfindung versteuern)

In case an employee faces dismissal, the employee is not legally entitled to a severance pay. It is only a voluntary service that can be offered to you, which of course happens only on rare occasions.

As a result, the amount of the severance pay is also not set by law. It is because of this fact that you have to put in some element of bargain to save yourself. The major guiding factor while planning for compensation for their employees is the number of years the colleague has worked in the company. Half a gross monthly salary is often granted per year of employment. For an employee who worked for 15 years in a company, for example, with a monthly salary of 3,500 euros, there is 26,250 euros as compensation.

Since the year 2006, severance payments have been treated as taxable wages (steuerpflichtiger Arbeitslohn). It is therefore nothing else than a wage payment. It is recorded on the employment tax statement (Lohnsteuerbescheinigung) as extraordinary income (außerordentliche Einnahme). A special feature is that the severance pay can be taxed after the Fünftelregelung.

Pay tax properly and save money with the Fünftelregelung

In the case of the Fünftelregelung, the clerk divides the compensation (Abfindung) paid by 5. Then one fifth of the annual income is added. Then the total income is taxed. The result is compared with the value that would have resulted without a severance pay. The difference is the so-called additional tax burden (steuerliche Mehrbelastung) that would have to be paid if the person who had been dismissed received only one fifth of the severance pay. The additional tax burden is then multiplied by 5, leaving more net of the gross.

Conditions for having the Fünftelregelung compensation taxed

There are certain conditions that apply to the application of the Fünftelregelung.

These requirements include:

  • Compensation (Abfindung) is paid for the loss of the job
  • Termination must have been issued by the employer
  • Compensation must be extraordinary income (außerordentliche Einkünfte)
  • Compensation is paid as a one-off payment

Note: Extraordinary income (außerordentliche Einkünfte) is income generated over a period of several years but paid in one year. The Fünftelregelung must be applied for.