date | theme

21. August 2019 | Settlement of a GmbH shareholder: Settlement clauses vs. Law

11. February 2020 | Severance pay in the event of company exit – legal limits and severance clauses

22. January 2021 | Payment of severance payments by moving abroad tax-free: is this possible?

23. May 2022 | Severance payments for partnership partners: how high they must be

21. June 2022 | Tax severance payments: How to reduce the tax burden (this contribution)

Severance payments can be paid to employees but also to shareholders upon leaving the company. However, severance payments are also subject to taxation. They are extraordinary income within the meaning of § 34 EStG. Therefore, they are subject to a tax reduction in the form of a tariff reduction. We explain how you have to tax severance payments and how you can reduce your tax burden.

Income tax is based on the principle of annual taxation, so this period also determines the progressive income tax rate. Problems therefore arise when remuneration or income for several years in one sum. Then the taxpayer is disproportionately burdened by the progression. Only distributed inflow leads to a lower control rate and thus to a lower overall load.

Income that atypically accrues is called extraordinary income. These incomes are listed in § 34 EStG, the second paragraph lists enumeratively which increases are considered extraordinary income. The income listed therein indicates extraordinaryness. However, this does not mean that a new type of income has been created. Rather, § 34 EStG is an independent tax calculation for a particular type of income. Paragraph 1 lays down the rule on taxation of extraordinary income.

§ 34 paragraph 2 EStG contains the reference to § 24 no. 1 EStG. § 24 no. 1 letter b contains the compensation for the cessation of an activity. This also includes severance payments. The compensation for the task can also be mutually agreed. The reason for not generating income is irrelevant. However, the compensation must be clearly different from the usual fees.

Compensation for the cessation of profit-sharing falls under § 24 no. 1 letter b EStG. However, profit-sharing in this sense only includes shareholdings. Consequently, § 34 EStG also includes severance payments paid for leaving a company. How the severance payment is calculated according to the amount to a partnership partner, we have explained in one of our other contributions.

The accumulation of income is to be checked separately before the severance payment within the meaning of § 24 (1) no. 1 letter b EStG falls under the tariff reduction. The assumption of an accumulation requires that the inflow occurs in an assessment period. Partial payments over several years are therefore excluded. If a partial amount of a severance payment is converted into a pension commitment, this amount is therefore not taxable in the absence of inflow as compensation according to § 34 (2) no. 2 EStG.

Originally, a general tax reduction was ordered in § 34 EStG. The current § 34 (1) EStG, which contains a tariff advantage, now applies. This corrects increased charges resulting from the progressive tariff related to the tax period. Therefore, § 34(1) EStG stipulates that the extraordinary income is to be arithmetically distributed over five years. Severance payments can be incurred for all types of income. The standard applies to all types of income, so that you have to tax all severance payments according to this scheme.

For surplus income, severance payments in the assessment period of the inflow are to be recorded. In determining profit by accounting, it depends on the investment period of the accounting. However, the law assumes that the remaining taxable income is unchanged in all five years. The tax on the severance payment is therefore determined according to § 34 (1) EStG as follows:

In a first step, the taxable income is determined, without the extraordinary income. The tax base thus calculated is then increased in the second step by one fifth of the extraordinary income. These two ESt amounts are then compared and the difference multiplied by a factor of five. The amount thus determined is the income tax on extraordinary income.

§ 34 EStG can be fully used by unlimited taxpayers. Spouses assessed together shall be treated jointly as taxable persons when assessed together. However, in certain cases a higher tax relief can be achieved by the separate assessment. From the 2001 assessment period, paragraph 1 shall be granted ex officio without a request. The tariff reduction is decided in the income tax assessment procedure.

Taxable severance payments You then after the tariff reduction of § 34 (1) EStG, if it is advantageous for you. The relief effect depends on the amount of the remaining taxable income.

The tariff reduction, on the other hand, has a particularly favourable effect if the taxpayer only earns extraordinary income. The marginal tax rates will then rise five times slower than when the normal tariff is applied. The greatest relief effect occurs in the case of joint investments and only extraordinary income. The advantage is reduced as soon as the taxable person receives ordinary income in addition to the extraordinary income. It is completely eliminated if the top tax rate is already reached with the regular income. If you earn income of more than 52,882 euros, there is no longer a tax relief of extraordinary income. In particular, if, in addition to high extraordinary income, low unfavourable income is achieved, the unfavourable income is burdened disproportionately.

Therefore, you should plan the tariff reduction ahead of time. If you have an influence on when you tax severance payments, you can, for example, control the realization, you should ensure that beneficiary and non-beneficiary income in each of different investment periods. The consensual postponement of a payment to a subsequent year does not yet lead to an inflow and can only be regarded as an abuse of design if the time of payment is arbitrary and has no relation to the economic background.