No income tax on severance pay for waiving compulsory portion - German Court Rules Inheritance Waiver Payments Are Tax-Free
A recent ruling by Germany's Federal Fiscal Court has clarified the tax treatment of inheritance-related payments. The decision confirms that lump-sum or instalment payments made in exchange for waiving a compulsory share of an inheritance are not subject to income tax. Instead, they are treated as the tax equivalent of an inheritance itself.
The court's decision hinged on distinguishing between payments that compensate for services and those that simply replace an inheritance. Under German law, if a payment is classified as income—such as compensation for work—it falls under §1 of the Income Tax Act (EStG) and is taxable. However, the court ruled that payments made to waive a compulsory inheritance share do not qualify as income.
Even when these payments are spread over multiple instalments, they remain exempt from income tax. The only potential tax liability arises under gift tax rules, not income tax. The Federal Fiscal Court in Munich reinforced this position by treating such payments as the tax equivalent of an inheritance, aligning with previous rulings by the Federal Tax Court. The distinction rests on the economic substance and legal intent behind the payment. If the payment is purely for relinquishing inheritance rights, it avoids income tax classification entirely.
The ruling provides clarity for those receiving payments in lieu of inheritance rights. Such sums will not face income tax, regardless of whether they are paid as a lump sum or in instalments. However, gift tax may still apply, depending on the circumstances of the transfer.
