GERMANY’S TAX LAWS IN A NUTSHELL (updated 30 May 2021)
In Germany, the calendar year = the tax year.
Hence, income taxes by individuals, for instance, are filed per calendar year (for individuals/income tax, see I. below). The same is true for VAT returns (assuming that you are an “entrepreneur” in terms of German VAT laws, for VAT, see III. below).
Nonetheless, under German accounting laws a business or a company may have a deviating business year (e.g. ending on 31 March, 30 April, and so on). As a conseqence, the entire business years’s income will be taxed as of the date in which that business year ends (for business taxation, see II. below).
Therefore a company (such as a GmbH, an AG or a GmbH& Co KG) might want to effectively change its business year from the calendar year to a deviating business year in order to trigger a “tax pause”, moving taxable income to a later tax year. However, corporate law steps (usually notary involvement) and, not to be forgotten, the approval of the tax office are needed for such change to be tax-effective.
If you live in Germany, irrespective of your nationality, you will be subject to resident income taxation on the basis of your world-wide income, unless tax-treaty protection applies.
1. Income tax rates and free amounts
In 2021, a taxable income of EUR 9,744 is income tax exempt (twice that amount for a married couple), in 2022 to be raised to EUR 9,984 (FY 2019: 9,169, FY 2020: 9,408). Further, exceeding income up to EUR 55,961 (twice that amount for a married couple) is taxed progressively, with rates increasing from 14% to 42%. In FY 2021, Income portions exceeding EUR 57,919 (double that for a married couple) up to EUR 274,613 (double that for a married couple) are taxed at the 42% top rate (but for capital income see 4. below).
2. “Rich tax” rate
Finally, a “rich tax rate” for income portions exceeding EUR 274,613 (double that for married couples) at a rate of 45% applies. In other words, the top income tax rate in Germany (in 2021: capturing income portions exceeding EUR 274,613 for a single-filing individidual) is 45% (but for capital income see 4. below).
3. Income tax calculation example
On top, the solidarity surcharge (SoliZ) needs to be reflected (details below, under 5.).
Tax Calculation Example, using an income tax calculator provided by the German Federal Ministry of Finance (BMF): You are a resident of Germany since 2020 (irrespective of you citizenship). Your taxable (worldwide) income in FY 2021 is EUR 300,000. German tax burden for FY 2021:
- EUR 124.094,37 total tax charge (income tax + SoliZ) = 41.37%
- EUR 117,62500 thereof income tax (ESt), = 39.21% burden
- EUR 6,469.37 thereof soldiarity surcharge (SoliZ), = 2.16% burden
4. Capital income taxation – 25% rate (plus SoliZ)
However, the income tax liability is different if your taxable income includes capital income (e.g. capital gains on disposal of shares, interest income, dividends). Effective as of 2009 and as an exception to the general income tax rate for all other types of income, a beneificial 25% income tax rate (including solidarity surcharge: 26.375%) was introduced. In many cases (dividends, interest rates and/or other capital income potions paid out by a German financlai institution) that tax is automatically withheld at the source – and that’s it.
So, in the example above (3.) it may well be that on top of the EUR 300,000 income the individual earns capital income taxed at the 25% (precisely 26.375%) capital income tax rate, withheld and paid at the source (“Abgeltungsteuer”.
To add more complexity: The 25% capital income tax rate will not apply if you own a substantial amount in a company – for instance 30% in a GmbH. If you receive a dividend from such GmbH, 40% of it is exempt and 60% (not 100%) is taxable at your general income tax rate. In other words, if the 25% rate is not available, you will usually at maximum pay 0,6×45% = 27% income tax (partial income system “Teileinkünfteverfahren”).
The determination on whether capital income falls under the 25% rate or the general income tax rate (in most cases with 60% exemption) is complex and should be assisted by a tax law professional.
5. Solidarity surcharge (SoliZ)
The above is not the full income taxation story. Introduced in 1991 by Helmut Kohl’s government, the solidarity surcharge (Solidaritätszuschlag) of 5.5% may be added to the income tax charge (and also to the corporate incme tax, paid by companies). Hence: Multiply your tax rate by 0.05 to calculate the additional solidarity surcharge burden (as in the example sub 3. above). The sum of income tax and SoliZ is your final income tax burden in Germany. There is no further “local” income tax (except for trade tax – potentially to be credited against the income tax – for certain business income).
Historically, the SoliZ surcharge was introduced to pay for the German reunification (1990). Following almost 30 years of discussion iw was partially abolished effective as of 2021. The nes rules (as of FY 2021):
- EUR 62,121 or less annual taxable income (single payer): SoliZ abolished.
- EUR 124,242 or less annual taxable income (joint filing by married couple): SoliZ abolished.
- EUR 62,121 – EUR 96.820 annual taxable income (single payer): partial SoliZ liability.
- EUR 124,242 – EUR 193.641 annual taxable income (joint filing by married couple): partial SoliZ liability.
- More than EUR 96.820 annual taxable income (single payer): full SoliZ liability (unchanged to previous years).
- More than EUR 193.641 annual taxable income (joint filing by married couple): full SoliZ liability (unchanged to previous years).
On capital income (25% income tax rate, see above 4.), the SoliZ in principle remains unchanged.
The above is subject to pending claims in front of Germany’s Federal Conctitutional Court. I share the criticism – the SoliZ should be abolished for all taxpapayers (priinciple of equal treatment of taxpayers).
6. Wage tax (income tax prepayments on salary) and social security
If you are employed in German, the employer will withhold and pay to the tax office not only wage tax (as a prepayment to your annual income tax) but also social security contributions. Technically, unlike in certain other countries, compulsory social security charges are not considered “taxes” as they are not collected by the tax office. Normally the statutory deductions are for pension, unemployment, health insurance and long-term nursing care. Costs are normally borne equally by employer and employee. The employer’s share of these contributions is not considered as taxable income. The employee’s portion is generally tax deductible.
7. Calculation the income tax assessmment base
Germany allows a number of deductions in order to calculate the tax base for wage taxes. For example, the expenses you incur when getting to your workplace are deductible (Pendlerpauschale).
8. Freelancers and income tax prepayments (if wage tax does not apply)
Freelancers in Germany will start to pay income tax once the first annual income tax declaration has been filed and processed by the local tax office. The Finanzamt will estimate your tax for the current year and assess quarterly prepayments (Vorauszahlungen) of a quarter of the tax on March 10, June 10, September 10 and December 10. The total tax liability is determined by filing an income tax return, which includes all types of income from all sources.
9. Timeline of income tax assessment
The annual income tax assessment is usually issued by the local Finanzamt between two and six months from the date the income tax return is filed. If you use a tax advisor you have 14 months to prepare and file your income tax return (example: for 2020 until end of February 2022). If you do not use a tax advisor you need to file earlier: The deadline is seven months end of July.
10. Church tax
Peculiar and due to a long history: Taxpayers being members of a recognized German church (typically: protestant, catholic and jewish denominations) will be subject to church tax to be paid on the annual taxable income. The church tax rate depends on the local state (Bundesland).
Corporations are taxed while partnerships and similar structures are transparent (i.e. taxation a the level of the shareholder/partner, irrespective of a disribution of the profit).
A German corporation (such as a GmbH or AG) is subject to corporate income tax (Körperschaftsteuer, CIT) with its annual taxable profit. The tax rate is 15%, but solidarity surcharge at a rate of 5.5% of that tax needs to be added. Hence, the overall tax charge (including solidarity surcharge) is 15,825%. There is no progression in the CIT rates.
However, many businesses, e.g. family-owned businesses are structured as GmbH Co & KG. This is a transparent entity with the general partner being a corporation (GmbH). The taxable profits are annually taxed in the hand of its respective shareholders (income tax, unless that shareholder is s corporation). The limited partner normally has a profit share of nil or close to nil.
The situation is different with German trade tax (TT). The TT burden can be higher than corporate income tax liability.
Each corporation, commercial partnership or branch of a non-resident company is subject to local German trade tax if it (i) pursues business activities (unless exempted) or (ii) qualifies as a deemed business due to its legal form.
The city or municipalities assess individual trade tax rates. For example, a large city such Frankfurt am Main has a trade tax rate of 16.10% (total tax burden, including CIT/solidarity surcharge: 31.925%). The small city next door, Eschborn, levies trade tax at a rate of 9.80% (total tax rate burden, including CIT: 25.625%). This is a typical pattern in German metropolitan areas. Trade taxes are typically lower if you move out of the city. Berlin is an exception. Berlin’s trade tax rate is 14.35% and significantly lower than in other large German cities.
An option is to set up the company in a neighbouring municipality . Many of these communities charge the statutory minimum trade tax rate of 7%. This adds up to a tax charge of 22.825% – the lowest tax burden you can get as a company in Germany, unless you can claim specific tax privileges.
Germany’s value-added tax (VAT) system is similar to the VAT regime of other EU countries. No wonder – the German VAT Act reflects (and must comply with) the European Union’s VAT Directive.
Germany’s regular VAT rate – except for the second half of 2020 – is 19%, the unified reduced rate (e.g. food, newspapers) is 7%.
As part of a corona tax relief package, VAT was lowered to 16% and (reduced rate) 5% for the second half of 2020. The regular rates of 19% / 7% is effective again as of 1 January 2021. The moment of providing the service is decisive, not the point in time the invoice is being issued.
A number of services are VAT-exempt, such as renting a flat or buying a house (this trigger Real Estate Transfer Tax though, see IV.).
If you are a business or an entrepreneur you can reclaim VAT paid, certain requirements being met.
Small entrepreneurs can make use of the small entrepeneurs rule: If your annual turnover does not exceed EUR 22,000 (as of FY 2020) you may be exempted from invoicing VAT – but at the same time have no right of claiming input VAT from your suppliers’ invoice.
IV. REAL ESTATE TRANSFER TAX (RETT)
The acquisition of German real estate is VAT-exempt, but subject to real estate transfer tax (“RETT”, Grunderwerbsteuer). RETT is imposed on the agreed consideration (usually purchase price) at a rate of 3.5% up to 6.5%, depending on where in Germany (in which Bundesland) the real property is situated.
It is usually agreed in the notarized purchase agreement that RETT is borne by the purchaser. Hence, the tax authorities usually submit the RETT assessment to the buyer. Upon such notice, RETT needs to be paid within one month in order to avoid fines and penalties.
These are the RETT rates (by Bundesland) as of 30 May 2021:
V. INHERITANCE AND GIFT TAX (Erbschaftsteuer)
The German inheritance and gift tax (“Erbschaftsteuer”) is the most relevant tax not (yet) explained in this overview, but to some extent in the blog.
In a nutshell, the unified inheritance and gift tax also captures gifts, as the legislator believes that gifts are made to possibly circumvent an inheritance tax liability. Similar to income tax or corporate income tax principles, for German tax residents the worldwide assets are taken into account when calculating an inheritance tax liability.
The tax free amounts for donations to children or grandchildren are EUR 400,000, for spouses EUR 500,000. For other recipients, the tax-free amounts are much lower. In a donation scenarios these tax-free amounts are available (again) after ten years.
There are more tax-free amounts available, depending on the resepctive asset being passed on. The transfer of a business may be fully inheritance or gift tax-exempt, certain requirements being met (for instance, typically the business needs to be contuniued for a number of years).
Donations or acquisitions by heirs exceeding the free amounts (specified above) are subject to an inheritance/gift tax at a rate of 7% up to 30% (by close relatives) or even 50% (recipient is no close relative).
VI. FINAL REMARKS
Currently, taxes in Germany are probably above international average. But on the other hand, there are certain ways to limit the assessment base of a respective tax. Moreover, some income may be excluded (free amounts) or simply not be taxable (out of the scope of the seven income categories as defined by the German Income Tax Act). Selling a house (used exclusively for own residential purposes or held for more than ten years) or selling a crypto asset (Bitcoin) owned for more than 12 months may not be taxable for German income tax purposes.
Depending on what you own (property tax for real estate owners), what you do (e.g. lottery tax) or what you buy (energy, alcoholic or tobacco products, coffee) other taxes may apply.
Foreign taxes will either be credited on the German tax charge, or foreign sources of income are exempted from German income (or corporate income) taxation, based on applicable tax treaties. For income tax and corporate income tax purposes, Germany has such tax treaties with almost all industrialized countries. For inheritance and gift tax purposes, there are currently six tax treaties in force for Germany (inter alia with the United States).
“Two thirds of the world’s tax literature is in German,” is repeatedly heard in Germany. I do not think this is accurate but who knows. Honestly, myself (and my colleague StB Manuel Brühl) are part of this “problem” due to our contributions to German tax and law books and technical periodicals.