Severance Payment

Severance pay in
employment law after termination of employment contract

In practice, the employer often pays a severance to the employee for the loss of his or her job after termination. The reason for such severance payments is rarely based on a pronounced social awareness; usually the employer simply agrees to a severance payment in order to obtain clarity about the termination of the employment relationship and to be able to tick off the matter. This is because, until the legally binding conclusion of dismissal protection proceedings, there is a risk for the employer that the invalidity of the dismissal might ultimately be determined.

This would not only mean that the employee must continue to be employed, but also that the employer must pay the full remuneration for the entire period between the expiry of the notice period and the conclusion of the dismissal protection proceedings.

What determines the amount of a severance payment in employment law?

Since there is no legal entitlement to severance pay, the amount of severance pay is also purely a matter of negotiation. In order to determine an amount of a severance payment, the term “standard severance” is frequently used both in out-of-court settlement negotiations and in conciliation proceedings before the labor court.

Standard severance formula

1/2 monthly average salary (gross) x number of years of employment

= amount of severance pay

If an employee was employed for 8 years at an average gross salary of most recently €4,500.00, the severance payment amount according to this formula would be €18,000.00 gross according to the standard severance formula (0.5 x 8 x 4,500).

However, a settlement deviating from this formula of standard severance is often agreed upon, since the amount of the settlement is the result of free negotiation. Even a settlement suggested by the labor court in the conciliation hearing is merely a proposal that cannot be reached without the agreement of both parties.
A very important factor in achieving a satisfactory severance payment, both in and out of court, is of course the negotiating skills and experience of the parties involved.

  • The prospects of success of the action for protection against dismissal
  • The economic situation and performance of the employer
  • The social situation of the employee (so-called social data), i.e. above all:
    Age, maintenance obligations and length of service.

Ultimately, it is therefore not possible to reliably determine a specific severance payment amount in advance. The formula of standard severance, taking into account the other aforementioned factors, can only serve as a rough guideline to look at a range in which a severance payment might be realistic.

The result that can actually be achieved depends on how strong the legal position is with regard to the possible invalidity of the termination and how forcefully and convincingly the available arguments can be put forward and enforced. Take advantage of an experienced specialist in employment law who is familiar with the argumentation patterns and negotiation strategies of employers.

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Taxes and social security contributions payable on severance payments?

If a severance payment for the loss of a job has been agreed, the employer must account for and pay out the severance payment. It makes no difference whether the severance payment was agreed in a court settlement or as part of a termination or settlement agreement.

1. Is the severance payment taxable?

Yes. The severance payment is neither tax-exempt nor do special allowances apply (such allowances used to exist until the end of 2005). The severance payment is therefore subject to income tax in full. The only tax advantage that the severance payment offers compared to a regular salary is the so-called 5-th rule. According to this, the severance payment is taxable, but tax-privileged: The tax burden can be spread over five years, so that effects of the lower tax progression can be used. The actual amount of income tax depends on the individual tax characteristics of the taxpayer. There is no kind of flat tax or flat tax rate for severance payments.

2. Is the severance payment subject to social insurance?

No. The severance payment is not subject to social security contributions if it is paid to compensate for the loss of the job in accordance with §§ 9, 10 KSchG. In a settlement in which a severance payment is agreed, it is therefore important to ensure that no formulations such as “compensation for outstanding remuneration or services rendered” or similar are used. Instead, the purpose of the severance payment as compensation for the loss of the job has to be made clear explicitly.

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