Employment Law2026-09-05

How is my severance pay taxed? The one-fifth rule explained simply

Severance pay is subject to income tax, but not to social security contributions – and the one-fifth rule can often noticeably reduce the tax burden. I explain how the calculation works and what to watch out for when it comes to the timing of payment.

You have negotiated a severance payment, or one is on the horizon – and then comes the sobering moment: on paper the figure looks good, but how much is left after tax? It is a fair question, because the tax office treats a severance payment differently from your ordinary salary. Anyone who does not know this often gives away real money when it comes to the timing of payment.

In brief

Severance pay is fully subject to income tax, but exempt from social security contributions. So you pay no contributions to pension, health, long-term care or unemployment insurance on it. For income tax, the so-called one-fifth rule under section 34 of the Income Tax Act (§ 34 EStG) usually applies. It cushions the jump in your tax rate caused by the one-off payment. How strong the effect is depends on the timing of payment and on your other income in the same year. How the amount of a severance payment is calculated in the first place is something I explain in a separate article: How much severance pay is typical?. Here, we are only concerned with the tax.

How I can help you

I assess whether and how strongly the one-fifth rule works in your case
I advise you on the most tax-efficient timing of payment before you sign the termination agreement
I coordinate with your tax adviser so that the negotiation and the tax assessment fit together
I review the severance clause in the settlement or termination agreement for tax pitfalls

What happens for tax purposes – and what does not

For tax purposes, a severance payment counts as compensation for the loss of your job within the meaning of section 24 no. 1 letter a of the Income Tax Act (§ 24 Nr. 1 Buchstabe a EStG) – as a substitute for income that would otherwise have been received. That is why the tax office taxes it like earned income: it is subject to your personal income tax rate, plus the solidarity surcharge and, where applicable, church tax.

For social security purposes the position is different: a severance payment is not remuneration for work performed, but compensation for the future loss of your job. As a rule, therefore, no social security contributions are payable on it. Important: this only applies as long as the employer is genuinely paying the severance as compensation for the loss of the job. If it is a disguised replacement for outstanding wages or holiday pay, this does not apply. Such components remain subject to wage tax and social security contributions in the normal way. Make sure the settlement statement sets them out cleanly and separately.

The one-fifth rule – how the calculation works

Without a special rule, a large one-off payment would push up your marginal tax rate in the year in which it is received. The progressive nature of income tax would then place a disproportionately heavy burden on the severance payment. That is precisely what section 34 of the Income Tax Act (§ 34 EStG) is intended to soften.

To do this, the tax office calculates as follows:

It determines the income tax on your taxable income without the severance payment.
It adds one fifth of the severance payment to that income and recalculates the income tax.
The tax office multiplies the difference between the two tax figures by five and adds it to the tax from step 1.

The upshot is that only one fifth of the severance payment is notionally fed into the progression. The tax office nonetheless captures the remaining four fifths at the same effective tax rate. The effect is all the greater the further your other income in the year of payment sits below the top tax rate. Where your income is already very high, however, the one-fifth rule often brings little benefit: your marginal tax rate is already close to the maximum.

Since 2025, your employer no longer carries out this calculation in the payroll. The severance payment is subject to normal wage tax deduction there. Instead, the one-fifth rule is applied exclusively by the tax office in the assessment procedure – for which you have to claim the tax relief in your income tax return.

Requirements and exceptions that are often overlooked

The one-fifth rule does not apply automatically just because a payment is labelled a “severance payment”:

Concentration of income: The rule requires the severance payment to be received as a single sum within one assessment period and thereby to place an exceptional burden on the progression. If the employer pays the severance out in instalments over several years, the relief is lost or reduced.
Comparison with what would have happened anyway: In the year of payment, you must not be losing more income through the early termination than you would otherwise have earned. If you are, the tax office may call the one-fifth rule into question.
Timing of payment: Is the severance payment received this year, or only in the following year? For tax purposes this can make a considerable difference, depending on how high your other income is in each of those years. This is a point you can still shape when negotiating the termination agreement, but generally not afterwards.
Interaction with unemployment benefit: The severance payment itself is not subject to social security contributions. Under certain conditions, however, it can lead to your entitlement to unemployment benefit being suspended. I assess this question separately from the tax.

The process: how I approach it for you

Where a severance payment is on the table, I first assess your likely taxable income in the year of payment. To do this, I add together your salary up to the leaving date, any new income and other sources of income. On that basis, I estimate whether a later payment is worthwhile. That is often the case where there is a gap between the termination and a new job. For the actual tax calculation and the return to the tax office, I work closely with your tax adviser. My role is to set these tax levers correctly while the termination agreement or court settlement is still being negotiated – before you sign anything.

A typical example

An employee is negotiating a termination agreement with a severance payment in the autumn. Her employer wants to make the payment before the end of the year, because he wants to account for it in the current financial year’s budget. By then, however, the employee has already received a high regular salary. The severance payment would therefore be concentrated in a year with already high income, and the one-fifth rule would provide barely any relief. If, by contrast, she has the payment contractually deferred to January of the following year, the smoothing of the progression takes effect far more strongly – by then she is either unemployed or on a lower starting salary. This is a difference she can negotiate, provided she raises it in good time, that is, before signing.

Common mistakes

Not negotiating the payment date: Accepting the payment date proposed by the employer without checking it often means giving away the single biggest tax lever.
Mixing severance pay with ongoing salary: If the final settlement does not draw a clean line between severance pay, remaining holiday, overtime and bonuses, there is a risk of incorrect tax and contribution deductions.
Misunderstanding the one-fifth rule as a guarantee: It is not a tax exemption, but simply a method of calculation to counter the progression – where your other income is low, the effect may be modest.
Raising tax questions only after signing: Once the termination agreement is signed, you can generally no longer change the timing of payment.

If you currently have a termination agreement with a severance payment in front of you, you can still avoid these mistakes right now – at the moment of signing: have your settlement agreement reviewed.

Frequently asked questions

Do I have to apply for the one-fifth rule?

Since 2025, your employer no longer applies the one-fifth rule when deducting wage tax. The severance payment is subject to normal wage tax deduction there. You have to claim the tax relief yourself in your income tax return, because only the tax office carries out the calculation under section 34 of the Income Tax Act (§ 34 EStG) in the assessment procedure.

Do I pay church tax on the severance payment?

Yes, provided you are liable for church tax. The tax office levies church tax on the proportionate income tax attributable to the severance payment, just as it does on any other taxable income.

Does the severance payment affect my unemployment benefit?

The severance payment itself does not reduce the amount of your unemployment benefit. Under certain conditions, however, it can lead to your entitlement being suspended for a limited period – for example, where you do not observe the ordinary notice period in the event of an early termination. I assess this independently of the one-fifth tax rule.

Can I still change the timing of payment after the event?

Once the termination agreement is signed, or after the court settlement, generally no longer, because the payment date is usually fixed on a binding basis there. That is why you should plan for tax before you sign.

Is the one-fifth rule worthwhile even for a small severance payment?

Yes, the principle applies regardless of the amount – but the noticeable effect depends on how far your other income in the year of payment is from the top tax rate. Where your other income is low, the relief can, in relative terms, even turn out to be greater than with high severance payments.

This article provides general information and is no substitute for legal advice in an individual case. Last updated: 2026-09-05.

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