Three Severance Pay Tax Pitfalls You Should Avoid

Receiving severance pay after a termination may feel like financial relief – until pay day, when you see the tax deductions. In Germany, severance payments are fully subject to income tax. At higher incomes, severance can also trigger solidarity surcharge and, for church members, church tax. While you cannot avoid taxation of severance pay entirely, there are ways to reduce the tax burden if you plan ahead. The most important tools are the well-known “one-fifth rule” (§ 34 EStG) and – for church members – an application for partial church tax relief. Both are no-brainers, yet both are frequently forgotten in practice. A third lever is timing: shifting the payout into a more favorable tax year can save a lot of money. Here is how:

Key takeaways

• Severance pay is fully taxable in Germany and can push you into a higher tax bracket due to income “bunching.”
• The one-fifth rule can soften the progression effect – but only if its conditions are met, and you actually apply for it in our annual tax filing. 
• Bad timing of the payout (e.g., December instead of January) is one of the costliest and most common mistakes.
• Church members can often get up to 50 % of the church tax on severance remitted – but only on formal application. Which is often forgotten.
• Additional tax-saving levers exist (insurance top-ups and advance payments, work-related expenses, etc.) but require early planning.

Severance pay is subject to income tax

Why is severance pay taxed like regular salary at all? A fair question. One could argue that severance in Germany is not “extra pay for past work” but compensation for the loss of the job – closer to damages than income. In fact, Germany’s Federal Fiscal Court once held this view. If that logic had prevailed, severance payments could have remained tax-free.

But the legislature – and now the courts – have aligned in the opposite direction. Since 2006, severance pay is taxed as income regardless of amount. The consequences for employees can be harsh: a one-off payout within one calendar year causes a “bunching” of income, which in turn pushes the progressive tax rate sharply upward.

Progressive tax rate 

This is the simplified effect of the progressive tax rate (for a single person, 2024) in a nutshell:

Taxable income	Marginal tax rate
up to €11,604	0 %
€11,605 – €17,005	14 % – 24 %
€17,006 – €66,760	24 % – 42 %
€66,761 +	42 % 45 % above €277,826

Solidarity surcharge (“Soli”)

Since 2021, roughly 90 % of taxpayers no longer pay Soli – unless a severance payout suddenly pushes them above the Soli thresholds. Then all of a sudden, the Soli re-appears on top of the already higher income tax. This is a common and expensive surprise, even for “normal” earners.

No social security contributions

The good news: severance pay is usually not subject to pension, health, nursing-care or unemployment insurance contributions.

Tax Trap 1 – Forgetting the One-Fifth Rule

The so-called one-fifth rule (§ 34 EStG) spreads the severance – only fictionally – over five years when calculating income tax. This mitigates the progression effect – especially when the severance is high and the remaining annual income is low. The rule works best at medium income levels. At very high or very low incomes, the relief shrinks or disappears entirely.

Requirements for the one-fifth rule

1. The payment must compensate for lost or future income (typical in termination cases).
2. The payout must occur in one lump sum (or within a single calendar year; ≤ 10 % may spill into the next year).
3. There must be a “bunching of income”: the severance must increase your total income beyond what you would have earned if the employment had simply continued unchanged.

Example: Employee earns €3,000/month and is terminated on 30 June 2025. Severance: €20,000. Lost salary July–December: €18,000. Because the severance causes higher total income than continued employment, the one-fifth rule applies. Approximate tax saving: ~€500.

The one-fifth rule is not the only option

Sometimes it is more tax-efficient to skip the one-fifth rule and instead shift the payout into a lower-income year – even if that means losing the rule entirely. Example: late-year settlement, planned sabbatical, or full-year unemployment after termination.

From 2025: no longer automatic application 

Until 2024, payroll systems applied the one-fifth rule automatically. From 2025 onward, you must actively request it in your tax return. Forgetting it can be very expensive. If you are using the services of a tax advisor, make sure that the application has been filled out. Most tax software programs check and automatically apply the one-fifth rule.

Tax Trap 2 – Bad Timing of the Payout

Taxpayers who can plan their income may spread or shift the payout to reduce the overall tax load. Even a one-day shift – from 31 December to 1 January – can move the entire tax to the following year and dramatically change the rate due to lower income, loss of Soli liability, or both.

Splitting the payout across years

The Federal Fiscal Court explicitly allows employers and employees to agree on the payout date. If the severance is split over several years, each portion is taxed separately – potentially at a lower rate. This is only advisable with financially stable employers.

Shifting over the year-end

If you already know during negotiations that your income next year will be significantly lower (e.g., unemployment, sabbatical, lower-paid job), push the payout into January.
This can:

• reduce the progressive rate,
• prevent the return of the solidarity surcharge,
• increase net severance by thousands of euros.

Make sure the contract states the later due date – payroll “mistakes” in December cannot be undone.

Always include all income sources

Do not decide based on severance alone. Consider spouse income, rental income, capital gains, benefits, etc. Run the numbers with a tax advisor before signing anything.

Tax Trap 3 – Forgetting the Church Tax Relief

Members of a religious community not only pay income tax on severance pay, but usually church tax as well. What many people do not know: most churches have long granted a voluntary partial remission (often up to 50 %) on church tax levied on severance payments. The reasoning is simple: a severance is treated as a special (extraordinary) payment, not as recurring salary.

There is no legal entitlement to this remission, but the practice is well established. Note that the remission increases the underlying income tax, which slightly reduces the net benefit.

The procedure varies by federal state. In Berlin, for example, the application is filed in writing (informal letter) with the Archdiocesan Ordinariate, after the tax assessment has been issued and before the assessment becomes final.

Additional Tax-Saving Options (Often Overlooked)

Beyond the “big three” (one-fifth rule, payout timing, church tax), employees have a few more levers. They are narrower in scope but can still save meaningful money – if planned early.

1. Contributing severance to a company pension plan (bAV)

Under the so-called “multiplication rule” (Vervielfältigungs­regelung), one-off contributions into a pension scheme made in connection with termination remain tax-free up to a high limit:

• 4 % of the annual pension ceiling (2024: €7,550/month)
• multiplied by the number of service years (max factor 10)
• plus an additional €7,248 tax-free amount

The contribution can be paid in installments until the ceiling is reached. This option is available only once per employment relationship.

2. Picking the “right” tax class (Ehegattensplitting)

Changing tax classes (e.g. III/V vs. IV/IV) does not alter the final tax result – the annual assessment evens everything out. But it does influence monthly net payouts (liquidity) and therefore matters for cash planning during the year of the severance.

3. Prepaying private health insurance (PKV)

Privately insured (and voluntarily statutory-insured) taxpayers may prepay health insurance contributions for up to three years. While unrelated to severance taxation per se, this frees up future “basic allowance” room for other deductions (e.g. disability insurance premiums).

4. Reducing taxable income through work-related expenses

Some deductible expenses are often forgotten but can meaningfully lower taxable income in the severance year:

Expense type	Example	Why it helps
GWG (< €800 net)	office chair, laptop, textbooks	immediate full deduction
Training / upskilling	certificate courses during garden leave	deductible as Werbungskosten
Legal fees	attorney costs for unfair dismissal claim	deductible even if you lose

(Cash leaves your pocket, but the deduction may still be worth it.)

Frequently asked questions (FAQ)