Have you received a severance payment and are wondering how to legally and risk-free pay less tax? The one-fifth rule can reduce your burden, but it only works under certain conditions and – starting from 2025 – exclusively in the annual tax return. Below you will find a simple plan that guides you through the conditions, documents, and a quick calculation of the benefits.
Have you received a severance payment? Check if you can use the one-fifth rule and calculate how much you can actually save
If you have just received a severance payment, you can legally reduce taxes thanks to the one-fifth rule. From 2025, it can no longer be offset in advance with the employer – it is used exclusively in the annual tax return, allowing you to decide when and how to declare the preference. To qualify for the benefit, your severance must be a genuine compensation for job loss, replacing lost income and not outstanding payments (e.g., vacation, bonuses, overtime). It’s also important to have “income pooling” in one year – the total payments with the severance must be higher than what you would have earned by the end of the year if you had continued working. Conclusion?
Check the sources, sums, and dates of the income, because even a small payment in another year can weaken the preference, although the case law allows small side amounts (approximately up to 10% of the main severance) without losing the condition of ‘income pooling’. Create a mini-checklist and calculate the effect.
1) Gross severance amount and date of receipt.
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2) Income you would have had by December 31, if the contract had not been terminated.
3) Is there no regular payment component “hidden” in the severance?
4) Have you no installment allocation in the next year (with exceptions up to 10% or smaller maintenance additions).
5) Tax simulation with one-fifth rule vs. without.
In this way, you see how much the tax decreases through the progression clause, and at the same time, you plan the crediting of benefits, donations, or acquisition costs to accumulate the effect.
When is a severance truly a “relief compensation” and when is it considered ordinary income by the tax office?
Not every “severance” is a severance in the sense of the benefit. If the package includes outstanding bonuses, vacation pay, compensation payments, or bonuses owed for the past, these are ordinary salary components that lead to the loss of the benefit entitlement. The economic meaning is decisive: Does the money replace the job loss and future income, or does it only complement what was already owed? It is also important whether you acted under real pressure of the situation – in practice, an amicable settlement does not exclude the benefit entitlement if it was a concession and not a free choice without conflict. Ensure clear formulations in the contract/agreement – use phrases indicating “compensation” due to the termination of employment, instead of a catalog of ongoing benefits.
Another risk area is the deadlines and tranches. The one-fifth rule favors a one-time receipt – splitting over years weakens the “pooling”. However, you can safely have a small “advance” up to 10% of the main amount in another year or small protective measures (e.g., short bridging allowances), as long as they only complement the severance and do not dominate its main sum. What to do practically? Ensure a clear transfer plan, precise description of the title in the documents, and divide every position in the settlement into elements – what is pure severance and what is ordinary salary. Check the conditions step by step on the checklist – in a few minutes, you will recognize if your construction leads to the loss of the benefit entitlement.
Severance and social security contributions – how to separate non-contributory from contributory elements
Good news – the classic severance for termination of employment is not subject to social security contributions – it is outside the insurance system, as it is not a salary. The trap? “Occasional payments” that are de facto outstanding salary, compensation, or bonuses – they are subject to contributions. Therefore, name the elements precisely in the agreements with the employer and list them in the protocol/agreement. In one column – severance (compensation for job loss), in the other everything that is an ongoing benefit. This way, HR/Finance correctly mark the payment reasons, and you do not pay avoidable contributions.
In practice, it is helpful to have all documents confirming the conditions of the one-fifth rule complete – decision/agreement on termination of cooperation, cause description, calculation “what if you had worked until the end of the year”, breakdown of payments, and confirmation of the transfer time. Collect this immediately, as it is difficult to correct anything later. Also remember that the severance is generally fully “seizable” (collectible by the bailiff), so consider applying for protection of part of the funds in enforcement proceedings – there are situations where protection can be obtained.
Which path to choose to receive more and pay less – compare court settlement and agreement with the employer
If you were dismissed for reasons attributable to the company, a scenario according to §1a KSchG is possible – then the severance can amount to half a month’s salary per year of service, and the whole can usually be easily documented to claim the one-fifth rule. In reality, it happens that an amicable agreement or a judgment/an amicable decision in the dispute offers a higher sum, but requires better design of the clauses and payment dates to not destroy the “pooling”. Parallel check if protective allowances are considered (e.g., short bridging allowances, outplacement, contributions to insurance) – some of these do not affect the preference, provided they do not exceed half of the main severance and are socially justified.
How to approach the negotiations? Set the framework (financial target “A”, acceptable “B”), add tax conditions (one-time receipt in the year, no integration of outstanding benefits), ensure the wording “compensation” as well as the precise transfer date. Also make your own simulation – the gross amount does not reflect the actual tax benefit. Only the “net” comparison shows whether a slightly lower but one-time sum is worthwhile or a higher but split one.
If you have received a severance payment, you can realistically reduce taxes thanks to the one-fifth rule, provided you meet the rule of ‘income pooling’ and correctly separate the compensation from ordinary employee benefits. Want to do this flawlessly and formally? Rely on the tax return from Germany online with Taxando – step by step check documents, simulate the benefit, and submit the complete declaration without leaving home.
Maciej Wawrzyniak
In his private life, Maciej enjoys sporting challenges, playing the guitar, and swimming in the lake. He is also the proud father of three sons.
