Salary vs severance in Germany: What gets deducted and how to save on taxes

If you're working in Germany, your monthly salary is typically paid after automatic deductions for taxes and social security. These deductions are handled by your employer based on your tax class and other personal data. But when you receive a severance payment, for example, after a termination or settlement, the rules change significantly.

Understanding these differences is key to avoiding surprises and saving money, especially for expats unfamiliar with the German system.

What gets deducted from your salary?

Your employer deducts the following from your gross salary before you receive it:

•  Income tax (Lohnsteuer): Based on your tax class (I–VI), which reflects your marital status, children, and other factors.
• Solidarity surcharge: A small percentage of your income tax, only applicable at higher income levels.
• Church tax: If you're registered with a religious community, 8–9% of your income tax is deducted.
• Social security contributions: These include health insurance, pension, unemployment, and long-term care insurance. You and your employer split these costs roughly 50/50. 

All of this is calculated automatically by your employer’s payroll system, using the tax class registered with the Finanzamt (tax office).

What about severance payments?

Severance is a one-time payment made when your employment ends, often as part of a termination agreement or court settlement. It’s treated differently from salary:

• No social security contributions: Severance is not subject to health, pension, or unemployment insurance deductions.
• Fully taxable: However, it is subject to income tax and can significantly increase your tax rate for the year, since it’s added to your regular income. 

The “Fünftelregelung”: A way to reduce tax

To reduce the tax burden on severance, Germany offers the Fünftelregelung (one-fifth rule), as outlined in §34 of the Income Tax Act. Here’s how it works: 

• Your severance is divided into five equal parts for tax calculation purposes.
• The tax office calculates how much extra tax you’d pay if you earned just one-fifth of the severance.
• That amount is multiplied by five and added to your total tax, often resulting in a lower overall tax rate than taxing the full amount at once. 

This method helps soften the impact of progressive taxation, where higher income leads to higher tax rates.

Learn more about Rotwang Law

Important change in 2025

Until the end of 2024, employers could apply the Fünftelregelung directly when paying severance. As of January 2025, this is no longer permitted. Now, you must apply for the tax relief yourself through your annual tax return. This means:

• Your employer will deduct full income tax on the severance.
• You must file a tax return to request the Fünftelregelung.
• The tax office will review your case and issue a refund if the conditions are met. 

How to claim a tax refund

To benefit from the Fünftelregelung, you must: 

• File a German income tax return for the year you received the severance.
• Ensure the severance qualifies as “extraordinary income” (i.e., not paid regularly). 
• Confirm that the payment was made in a single calendar year (not split across years). 

If approved, the tax office recalculates your tax using the Fünftelregelung and refunds the difference.

An example of applying the Fünftelregelung
Let’s say you earn 40.000 euros annually and receive a 20.000 euro severance payment. Without the Fünftelregelung, your taxable income jumps to 60.000 euros, pushing you into a higher tax bracket. With the Fünftelregelung, the tax office calculates your tax as if you earned 44.000 euros (your salary plus one-fifth of the severance), then multiplies the extra tax by five. The result is usually a lower total tax bill.

Why legal advice matters

Navigating severance payments and tax rules can be tricky, especially for expats unfamiliar with German law. A qualified employment lawyer can: 

• Review and negotiate severance agreements.
• Ensure the contract is structured to allow tax benefits.
• Advise on timing and payment methods.
• Coordinate with tax advisors to optimise your refund.