How is a severance payment treated for tax purposes?
November 9, 2022 | 45,00 EUR | answered by Lorenzo Zimmermann
Dear tax advisor,
my name is Anneliese Hinze and I have been working for many years in a company that is now being restructured. I have been offered a severance package to terminate my employment. Now I am wondering how a severance package is treated for tax purposes and what impact this will have on my financial situation.
I have heard that severance packages can be tax-free under certain circumstances, but I am unsure if this applies to my severance package. I want to avoid having to make a high tax payment at the end of the year, so it is important for me to know how much the severance package will be taxed and if there are ways to save on taxes.
Furthermore, I am concerned about whether the severance package will have any impact on my social benefits or pension entitlements. I want to ensure that I have all the relevant information to make an informed decision and not jeopardize my financial future.
Could you please explain in detail how a severance package is treated for tax purposes and what tax consequences I may face? Are there ways to save on taxes or receive the severance package tax-free? And what impact will the severance package have on my social benefits and pension entitlements? Thank you in advance for your help.
Sincerely,
Anneliese Hinze
Dear Mrs. Hinze,
Thank you for your inquiry regarding the tax treatment of severance payments. It is understandable that you are concerned about the tax consequences and want to ensure that you have all relevant information to make an informed decision.
In principle, severance payments are subject to income tax. However, the level of taxation depends on various factors. In Germany, the so-called "Fünftelregelung" applies, which can provide tax benefits for severance payments. Under this rule, the severance payment is fully taxed in the year of receipt, but the tax burden is reduced by an allowance. The severance payment is spread over five years, and only one-fifth of it is added to taxable income each year. This usually results in tax savings, as the tax rate for taxable income is generally lower than for the entire severance sum.
It is important to note that the "Fünftelregelung" only applies to severance payments made due to termination of employment. Additionally, the severance payment must be made due to a legal claim or a court decision. Voluntary severance payments, for example as an incentive for a termination agreement, cannot benefit from the "Fünftelregelung" and are fully taxed.
To save taxes, it may be beneficial to negotiate with your employer whether the severance payment can be paid out in installments. This can spread the tax burden over several years, leading to a lower tax liability. Additionally, certain expenses, such as training costs or moving expenses, can be claimed as tax deductions and reduce the tax burden.
Regarding the impact on your social benefits and pension entitlements, severance payments can generally have an influence on these. A severance payment is usually considered as income and can therefore affect the calculation of social benefits such as unemployment benefits or sickness benefits. A severance payment can also be relevant for pension entitlements, as it can affect the pensionable periods.
It is therefore advisable to consult with a professional such as a tax advisor or a social security expert to assess your individual situation and clarify any potential impact on social benefits and pension entitlements.
I hope this information has been helpful to you and I am available to answer any further questions.
Best regards,
Lorenzo Zimmermann
