The one-fifth rule (Fünftelregelung) for severance pay
Reviewed by specialized labor lawyers · Updated: June 2026
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The so-called one-fifth rule (Fünftelregelung) under § 34 of the German Income Tax Act (EStG) can often reduce this burden considerably. In this article we explain clearly how the one-fifth rule works, when it can be applied and which common mistakes you should avoid.
What exactly is the one-fifth rule under § 34 EStG?
The one-fifth rule is a special income tax rate for so-called extraordinary income. This includes in particular certain severance payments, compensation and remuneration for multi-year activities. The background is that with a high one-off payment the progressive tax rate bites harder than if the same amount had been spread over several years. The one-fifth rule therefore notionally simulates a distribution over five years, without you actually having to receive the money in instalments. For tax purposes the calculation is done as if you received one fifth of the severance in each of five years; the tax saving results from the lower average tax rate this produces. Whether the one-fifth rule leads to relief in an individual case must always be calculated specifically.
How is the one-fifth rule calculated?
The technical calculation follows from § 34 para. 1 EStG and looks complicated at first sight, but always runs according to the same scheme. First, your normal income tax without the severance is determined (remaining taxable income). One fifth of the severance is then added and the tax on this increased income is calculated. The difference between the two tax amounts is multiplied by five – the result is the tax attributable to the entire severance. Through this procedure your tax rate on the severance rises less steeply than if the whole sum were taxed at once. The tax office or your tax software carries out these calculation steps automatically when the requirements of the one-fifth rule are met.
When does a severance count as extraordinary income?
Not every payment that your employer calls a “severance” automatically receives tax relief. The one-fifth rule requires that, for tax purposes, it is compensation within the meaning of § 24 No. 1 EStG or remuneration for a multi-year activity under § 34 para. 2 No. 2 or 4 EStG. With severance payments in employment law, this is generally compensation for income forgone due to the termination of the employment relationship. The payment must therefore economically offset the loss of future salary and must not merely be a voluntary bonus with no connection to the termination. In addition, case law requires that the severance be paid in a concentrated form in close temporal connection with the end of the employment relationship. If a supposed severance is merely structured as disguised ongoing salary, the one-fifth rule can be denied.
Requirements of the one-fifth rule for severance pay
Several conditions must be met for the one-fifth rule to apply. First, the payment must be a genuine compensation for income lost or to be lost, typically for the loss of the job. Second, a so-called concentration effect must exist: the compensation is essentially paid in one assessment period (calendar year) and thereby significantly increases your income in that year compared with previous years. Third, it must not merely be the back payment of salary claims already due or of ongoing pay. Fourth, the severance must not be split into many larger partial amounts over several years, because otherwise the concentration is lost. Whether these requirements are met is examined by the tax office in the tax assessment; careful structuring of the termination agreement or the settlement is therefore decisive.
Timing of payment: when is the one-fifth rule possible?
What matters is not the timing of the dismissal, but the actual receipt of the severance in your account. The favourable taxation under the one-fifth rule is generally only possible if the severance is paid in full in the year the employment relationship ends, or in close temporal connection with it, and a concentration of income occurs. In certain cases case law also recognises a split where a small partial amount flows in another year and is minor in relation to the main payment, as the Federal Fiscal Court (Bundesfinanzhof) has decided. But do not let yourself be tempted to have the severance paid out “for convenience” over several years in similarly high instalments; the tax relief is then usually lost. For employees with lower income in the year of the severance it can, in individual cases, also make sense to deliberately place the receipt in a year with lower other income in order to maximise the tax advantage.
Multi-year activity: the one-fifth rule even without a severance
The one-fifth rule applies not only to classic severance payments, but also to certain remuneration for a multi-year activity. An activity is multi-year under § 34 para. 2 No. 4 EStG if it extends over at least two assessment periods and covers more than twelve months. According to the case law of the Federal Fiscal Court, this can also include salary paid in a lump sum after the fact for a longer period, for example because bonus payments are accumulated and later paid all at once. The condition is that economically sensible reasons exist for the concentrated remuneration and that no abusive tax arrangement is intended. Particularly with extraordinary bonus or profit-share payments it can be worthwhile to have it checked whether reduced taxation under the one-fifth rule is possible.
Common structuring mistakes with severance and the one-fifth rule
In practice we repeatedly observe similar mistakes that can cost the tax advantage. Often the severance arrangement in the termination agreement is worded too imprecisely and fails to make clear that the payment is granted as compensation for income forgone due to the dissolution of the employment relationship. Equally problematic are constructions in which ongoing pay, bonuses or overtime remuneration are declared as part of the severance in order to appear to use the one-fifth rule. In addition, severance payments are often unnecessarily split into several larger instalments, even though a one-off payment would have been more tax-efficient. A further mistake is to rely solely on the employer’s payroll; the final tax assessment is made by the tax office in the income tax notice, and there the one-fifth rule can still be rejected or corrected after the fact. Timely, clean structuring and documentation is therefore more important than any later “rescue” in the appeal procedure.
How to use the one-fifth rule in practice
The one-fifth rule is a powerful instrument for significantly reducing the tax burden on a severance payment or other extraordinary income. The condition, however, is that the legal framework is observed correctly from the outset: clear wording in the termination agreement, a planned payout date and a clean separation between ongoing salary and genuine compensation.
Frequently asked questions
A severance payment qualifies for tax relief when it represents a genuine compensation for income that has been lost or will be lost. The typical case is compensation for the loss of the job following a dismissal or a termination agreement. The payment must essentially be concentrated within a single assessment period and must not merely be disguised ongoing salary. Whether these requirements are met depends above all on the wording of the contract and the specific structure of the payout.
The one-fifth rule often, but not always, results in a tax saving. It is particularly beneficial when the severance is high and is received alongside other income, so that without the relief a high top tax rate would apply. With rather small severance amounts or very low other income, however, the difference compared to normal taxation can be small.
If substantial parts of the severance are spread across several years, the concentration effect required for the one-fifth rule may no longer apply. The tax office then often treats the payments like normal salary, and the tax relief is lost. Only in exceptional cases does case law accept a small secondary payment in another year, provided it is clearly minor in relation to the main payment.
The one-fifth rule is a statutory calculation method and does not have to be expressly mentioned in the contract. What matters, however, is that the contract clearly describes the character of the payment as compensation for the loss of the job. This includes an unambiguous link to the termination of the employment relationship and to the salary claims being forgone. Clear wording strengthens your position vis-à-vis the tax office and increases the chances that the one-fifth rule will later be recognised.
Yes, the tax office is not bound by the employer’s payroll and can correct the one-fifth rule in the tax assessment. If it finds that the requirements for extraordinary income or for the concentration of income were not met, the severance is taxed normally after the fact. This can lead to considerable back taxes.
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