Taxing severance pay - fifths rule and tax tips

A severance payment can provide significant financial relief — but the tax office takes its cut too. In Germany, severance payments are generally subject to tax. However, the so-called ‘one-fifth rule’ can often significantly reduce the tax burden. In this guide, you will learn how taxation works and what options are available to you.

Is a severance payment taxable?

Yes. Severance payments are classified as extraordinary income for tax purposes and must be taxed in full. There is no general tax-free allowance for severance payments.

However, severance payments are exempt from social security contributions — no contributions are payable towards health, pension, care or unemployment insurance. Tax remains the main burden, however.

What is the fifths rule?

The one-fifth rule (Section 34 of the Income Tax Act) is a tax relief measure designed to prevent a one-off large payment, such as a severance payment, from being taxed disproportionately heavily due to progressive taxation.

Here’s how it works: when calculating tax, only one-fifth of the severance payment is added to your regular income. The resulting increase in tax is then multiplied by five. The result: the severance payment is taxed as if you had received it spread over five years.

Calculation example

The lower your regular income is in the year of the severance payment, the greater the tax benefit under the fifths rule.

What has changed from 2025?

An important change has been in force since 1 January 2025: employers no longer automatically apply the fifths rule when deducting income tax. Instead, they withhold the full amount of income tax on the severance payment.

What this means for you:

The fifths rule itself remains in place — you simply need to apply for it via your income tax return. Without a tax return, the benefit is lost.

Requirements for the fifths rule

Not every severance payment automatically qualifies. The following requirements must be met:

Concentration of income: The severance payment must be received in a single calendar year. If it is spread over several years, the one-fifth rule generally does not apply.

Extraordinary income: The severance payment must be paid as compensation for the loss of employment. Regular salary components or bonuses are not included.

Higher total income: The severance payment, together with your other income, must result in a higher total income than you would have earned in the same year without the severance payment.

Tax tips: How to optimise your severance pay

1. Postpone payment until the following year: If your employment ends at the end of the year and you expect little or no income in the following year, it may be advantageous to postpone the payment of the severance pay until the new year. The lower your other income, the greater the tax benefit of the fifths rule.

2. Pay into a pension scheme: A portion of the severance pay can be paid into a company pension scheme with tax relief. The tax-free maximum amount in 2026 is €40,560. This sum reduces your taxable income.

3. Increase income-related expenses: In the year you receive the severance payment, you can claim special income-related expenses — such as for professional development, job application costs or outplacement consultancy.

4. Check church tax: If you are liable for church tax, this will also be levied on the severance payment. In some cases, an application for partial exemption from church tax can be made in the case of extraordinary income.

5. Consult a tax adviser: For larger severance payments, it is almost always worth seeking advice from a tax adviser. The options for optimising your tax position depend heavily on your individual circumstances.

Entering the severance payment on your tax return

The severance payment is entered in your tax return as employment income in Appendix N. There is a separate field there for “Compensation / Employment income for several years”. Only if the severance payment is correctly declared as compensation there will the tax office consider applying the fifth-rule.

If you accidentally enter the severance payment as regular wages, the one-fifth rule will not be applied — and you may end up paying significantly more tax.

Frequently Asked Questions (FAQ)

Do I have to pay tax on a severance payment?

Yes. Severance payments are fully subject to income tax in Germany. There is no tax-free allowance. However, they are exempt from social security contributions.

What is the fifth rule?

A tax relief under Section 34 of the Income Tax Act (EStG), whereby the severance payment is taxed as if you had received it spread over five years. This mitigates the tax progression and often saves several thousand euros.

Do I have to file a tax return if I have received a severance payment?

Since 2025, filing a tax return has been mandatory in order to claim the fifths rule. Without a tax return, the tax benefit is lost.

When is the ‘one-fifth rule’ particularly worthwhile?

You will benefit most if your other income in the year of the severance payment is low — for example, because you have only worked for a few months or are unemployed in the following year.

Can I defer the payment of my severance pay?

In principle, yes, if your employer agrees. Postponing the payment until the following year may make sense from a tax perspective, but this must be agreed before the payment is made.

Does the severance pay affect my unemployment benefit?

The severance pay is not counted towards your unemployment benefit, provided the notice period has been observed. However, if the employment relationship is terminated prematurely, your entitlement to unemployment benefit may be suspended.

This article is for general information purposes only and does not replace tax or legal advice. Tax implications depend on your individual circumstances — if in doubt, consult a tax adviser or specialist solicitor.