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Reduced taxation – severance pay – termination agreement

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In the case of redundancy payments

is usually compensation for lost or foregone income, for which a tax reduction (so-called fifths rule) can be considered. The prerequisite for this is that there is an accumulation of income. This is the case if, in addition to the compensation payment, the taxpayer receives other income which, in total, is higher than the salary he or she would have received if the employment relationship had continued undisturbed.

In a recent decision, the German Federal Fiscal Court

ruled on the reduced taxation of compensation in the course of a termination agreement with subsequent early retirement. The court has clarified that in the event of payment of a severance payment in the context of a (mutually agreed) termination of the employment relationship, compensation for the loss of the job can in principle be assumed, so that reduced taxation can be considered.

In addition, the court clarified that subsequent pension income is also to be included with its taxation share in the comparison of whether there is an aggregation of income.

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B receives a severance payment of 36,000 EURO from his employer under a termination agreement as of 03/31/2017. In addition, he received current wages of EURO 14,000 and EURO 18,000 of taxable statutory retirement pension in 2017. In the entire year 2016, B generated income from employment of 57,000 EURO.
The compensation, the current income from employment and the taxable pension income together exceed the previous year’s income of EURO 57,000 by EURO 68,000. This therefore constitutes preferential compensation, which leads to an accumulation of income and is taxable at a reduced rate in accordance with the one-fifth rule.

According to this ruling, it can regularly be assumed in the case of termination agreements under agreement of a severance payment that it is a favored compensation if there is also an accumulation of income.

(For further comments and information, please see our Information Letter 11/2018).

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