In a ruling (BFH judgment of 2 December 2021, VI R 23/19), the BFH decided that aggregated overtime compensation is to be assessed at the reduced tax rate under § 34 Abs. 1 EStG. In the disputed case, employee X had overtime hours accrued from 2013 to 2015 paid out in a lump sum due to the termination of the employment relationship. The tax office recorded the overtime compensation (approximately €6,000) as additional wages and did not apply the reduced tax rate under § 34 Abs. 1 EStG. As a result, X's additional income was subject to a higher income tax burden, significantly reducing the net wage. The reason for this is the progressive income tax, under which a higher income tax rate applies to higher incomes.
Requirements for the Reduced Tax Rate
The prerequisite for the reduced tax rate is that the taxpayer has performed a multi-year activity at the company. More specifically, the activity should extend over at least two assessment periods and last more than twelve months (§ 34 Abs. 2 Nr. 4 EStG). Furthermore, the compensation must be purpose-specific, which should be apparent from the occasion of the payment. If these criteria are met, aggregated overtime compensation can be regarded as extraordinary income. However, the reduced tax rate is only granted if this income is paid out within a single assessment period.
In the disputed case, the overtime compensation extended over two assessment periods (2013–2015) and the activity at the company also lasted more than twelve months. The purpose-specific nature of the compensation arises from the fact that the employment relationship was terminated. In addition, the entire overtime was paid out in a lump sum. The requirements for the reduced tax rate under § 34 Abs. 1 EStG are therefore met.
Reduced Tax Rate under § 34 Abs. 1 EStG
The reduced tax rate under § 34 Abs. 1 EStG is calculated as follows (calculation based on an example with simplified figures):
Taxpayer M earns a gross income of €46,000 in the 2019 assessment year. In addition, she has the overtime compensation from previous years (2015–2019) paid out in a lump sum due to the termination of the employment relationship (€20,000).
Annual income €46,000
Overtime compensation €20,000
= Total gross taxable income €66,000
Income tax (on total gross) €18,939
Application of the reduced tax rate:
New total gross €50,000
(Annual income + 1/5 of overtime compensation)
Income tax payable thereon €12,295
Income tax without overtime compensation €10,753
(Annual income €46,000)
Difference €1,542
(€12,295 – €10,753)
Tax on overtime compensation (under the one-fifth rule) €7,710
(€1,542 * 5)
Tax on overtime compensation (without the one-fifth rule) €8,186
= Total tax savings €476
Frequently asked questions
Frequently asked questions
Does the reduced tax rate apply to overtime compensation paid out in a lump sum?
Yes. In its ruling of 2 December 2021 (VI R 23/19), the BFH held that overtime compensation paid retroactively in a lump sum within a single assessment period qualifies as extraordinary income under § 34 Abs. 1 EStG and is therefore taxed at the reduced rate (one-fifth rule). This mitigates the additional tax burden resulting from the progressive tariff.
What requirements must be met to apply the one-fifth rule (Fünftelregelung) to overtime compensation?
The underlying activity must span at least two assessment periods and have lasted longer than twelve months (§ 34 Abs. 2 Nr. 4 EStG). In addition, the payment must serve a specific purpose, for example in connection with the termination of the employment relationship. Finally, the overtime must be paid out as a lump sum within a single assessment period.
Why does paying out several years of overtime without the one-fifth rule lead to a higher tax burden?
German income tax is progressive, meaning the tax rate rises as taxable income increases. If overtime compensation earned over several years is paid out in a single year, it sharply increases annual income and is subject to a higher marginal tax rate. Without a preferential tax treatment, this results in a disproportionately high tax burden.
How does the one-fifth rule under § 34 Abs. 1 EStG work mathematically for overtime compensation?
First, the tax on the annual income without the compensation is calculated. Then, the tax on the annual income plus one-fifth of the overtime compensation is determined. The difference between these two amounts is multiplied by five, yielding the tax on the overtime compensation. This effectively spreads the progression effect over five years and reduces the tax burden.
What does 'purpose-related compensation' mean in the context of the reduced tax rate for overtime?
The payment must be made for a specific reason that justifies the lump-sum compensation – typically the termination of the employment relationship. An arbitrary or routine bulk payment is not sufficient. Only if the underlying reason explains the one-time payment do the overtime payments qualify as extraordinary income within the meaning of § 34 EStG.