If severance payments are made upon premature termination of an employment relationship, the question regularly arises as to the tax consequences and how these can be minimised as far as possible. The new Foundation Act, which came into force last year, can provide a sensible solution for many of those affected.
Severance payments that result in an accumulation of income in one year are taxed at a preferential rate. Accumulation occurs when the severance pay and any current earned income for the year in which the severance pay is paid are greater than the otherwise regular earned income for an entire year.
Such severance payments are taxed at a reduced rate for income tax purposes using the so-called one-fifth rule. In this case, the severance payment received is divided by five.
This amount is added to the remaining taxable income. The resulting tax amount for the fifth of the severance payment is then multiplied by five to determine the actual tax burden on the severance payment.
Since the German income tax scale is progressive, i.e. the tax rate increases with rising income until it reaches the top tax rate of 42 % plus solidarity surcharge of 5.5 %, i.e. a total of 44.31 % on a taxable income of 52,152 euros, someone who receives a severance payment must endeavour to earn as little other taxable income as possible in addition to the severance payment in the year of the severance payment. From a current income of 52,000 euros, he no longer saves any taxes even if the one-fifth rule is applied to the severance payment, as he is already subject to the top tax rate. The severance payment is then fully taxed at 44.31%.
It becomes even more expensive if current income and one fifth of the severance pay exceed the amount of 250,000 euros. From this income onwards, the so-called wealth tax applies. The tax rate then rises to 45% plus the solidarity surcharge, i.e. up to 47.48% in total.
The highest benefit from the preferential severance taxation is achieved if the remaining taxable income in the year of the severance payment is zero euros. In order to optimise the taxation of severance payments, it is therefore necessary to develop strategies aimed at reducing the remaining taxable income.
The taxable income of a taxpayer consists of the sum of his income from the individual types of income under the income tax law. Special tax expenses are to be deducted from this in order to ultimately determine the taxable income. One option in this situation might be to try to have no other current income for the year. Alternatively, it should be examined whether the existing positive income can be offset against corresponding tax-recognised losses from other sources of income in order to neutralise them. However, one can also consider offsetting current positive income with special expenses in the corresponding amount.
The Act to Strengthen Civic Involvement (Gesetz zur Stärkung des bürgerlichen Engagements) has greatly increased the practical relevance of an interesting design variant in this area since 01.01.2007.
The deductible special expenses have always included donations to charitable foundations. However, the legislator has now drastically increased the amounts that can be donated to the assets of a foundation to up to one million euros, § 10b para. 1a EStG (EUR 2 million for married couples).
In the case of larger settlements, for example, those who have no heirs or who generally wish to promote a charitable cause chosen by them, linked to their name, it may be interesting to claim this special expenses deduction.
If you combine these tax aspects with the desire to have a meaningful retirement task even after retiring from working life, the foundation solution becomes even more attractive.
For example, with a current taxable income of 200,000 euros and a severance payment of 250,000 euros, the regular income tax burden for a single person is 191,045 euros.
If one now reduces the current income to zero euros by setting up a foundation with a capital stock of 200,000 euros, a tax burden of only 69,081 euros arises.
The possible tax saving in this case is 121,965 euros. The own additional expenses amount to 78,035 Euro to establish a foundation with a capital of 200,000 Euro after all.
The manifold possibilities of the foundation are often not used because the own tax advisor has not been trained in this special field and therefore – also for liability reasons – does not take a position on effective foundation constructions when talking to the client. Here it is advisable to involve independent foundation consultants with many years of experience in the establishment and administration of foundations.
Cross-border foundation constructions should also be examined by the foundation advisor in order to generate increased benefits for the founder if necessary.
In the foundation formation phase, care must be taken to ensure that the founder selects foundation solutions which, in addition to the tax effects described above, also enable him to enjoy far-reaching advantages under civil law. Thus, the charitable trust foundation is usually the more flexible and cost-effective legal form of foundation compared to the foundation with legal capacity. This results, for example, in cost advantages both in the establishment and in the ongoing operation of the foundation. Furthermore, the inflow and outflow of capital can be regulated more flexibly by the founder, depending on the income situation of the founder.
by Dr. Johannes Fiala, Dr. Uwe Dörnbrack and Frank M. Strobelt
by courtesy of
www.stbverband-berlin-bb.de (published in Verbandsnachrichten, issue 04/2008)
www. deutsche-molkerei-zeitung.de (published in DMZ , issue 19/2008, page 42-43)
www.halstenbeker-magazin.de (published in Halstenbeker Magazin, issue 08/2008, page 22-23)
www.channelpartner.de (published in ChannelPartner, issue 35/2008)
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About the author
PhD, MBA, MM
Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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