What is the tax payable on?
Income tax is imposed on the income of individuals and partners in a partnership. While worldwide income is subject to taxation in the case of unlimited tax liability (see the section entitled “Who pays the tax?” below), limited tax liability means that taxation is based solely on domestic-source income within the meaning of section 49 of the Income Tax Act.
Accordingly, a range of personal and family-related tax benefits (such as income splitting for spouses, the basic personal allowance, and relief for certain special expenses or extraordinary financial burdens) cannot be taken into account, or may only be taken into account to a limited extent, when assessing a person for the purposes of limited income tax liability.
On certain types of income the tax is generally collected by being withheld from earnings or collected at the source.
Income from the following sources is subject to income tax:
- agriculture and forestry
- commercial business activity
- capital assets
- renting and leasing
- other income designated in section 22 of the Income Tax Act (e.g., income from statutory pensions or income from private sales transactions)
If a capital increase cannot be attributed to any of these types of income (e.g., because the increase was incurred through a gift, the sale of objects of everyday use, or a lottery win), it is not liable for income tax. Expenses related to such income cannot, however, be taken into account for tax purposes.
In the case of agriculture and forestry, commercial business activity and self-employment, the profit is classed as the income. Profits are computed on an accrual basis, as the excess of business receipts over business expenditure or, in the case of smaller agricultural undertakings, on the basis of average rates (section 13a of the Income Tax Act). In accordance with section 4 subsection (4) of the Income Tax Act, business expenditure is such expenditure as is occasioned by the operation of a business or the performance of an activity on a self-employed basis. To determine earnings in the case of other sources of income, the expenses incurred to realize, protect or preserve gross income (income-related expenses) are deducted from the total receipts for a particular source of income.
Normal living expenses (which invariably include, e.g., expenditure on food, clothing and housing) are not deductible as business or income-related expenses. This also applies to expenses occasioned by the business or social position of the taxpayer, even if such expenses are incurred in the promotion of his or her business or professional career.
Total income is calculated as the balance of profits/surpluses and losses from the different sources of earnings. Losses from one source of earnings may be offset against earnings from the same category or from a different source. Special rules restricting offsetting and loss deduction apply.
If losses cannot be offset during a tax assessment period (generally the calendar year), the loss is carried forward or back.
From the resulting total income, taxpayers over the age of 64 may, under certain conditions, deduct an amount of up to €1,900 annually as old-age relief. Taxpayers who are single and have children may deduct €1,308 as relief for single parents.
The relief for single parents was introduced with effect from the start of the 2004 calendar year. To be eligible for the relief, the taxpayer’s household must include at least one child who is registered as living there, and the taxpayer must be entitled to claim tax-free child allowance or child benefit for that child. The relief is reduced by one twelfth for each month in which these conditions are not met.
The figure left over is referred to as adjusted gross income.
After applying the deduction of losses (either a loss carry forward spread over time or a loss carry back that is limited in terms of amount), which is subject to the same restrictions as those for offsetting losses, taxable income is computed by deducting special expenses and extraordinary financial burdens from the adjusted gross income.
The taxable income determined in this manner forms the basis for the assessment of income tax according to the tax scale. This amount of tax constitutes the assessable income tax – with the amount reduced by credits for foreign taxes paid and any applicable tax relief (e.g., for expenditure on employment or services in or around the household) and increased by certain amounts (e.g., the amount of the entitlement to child benefit if tax-free child allowances have been deducted from taxable income because child benefits paid were not sufficient to effect the tax exemption stipulated in the constitution).
Employees are required by law to submit an income tax return in particular cases (for example, wages tax). In other instances, income tax will only be assessed under certain circumstances, e.g.;
- the taxpayer applies for assessment, especially to credit wages tax and withholding tax on income from capital (final withholding tax)
- either spouse applies for separate assessment or both spouses apply for special assessment during the year in which they married
- a loss from income other than that derived from employment has to be taken into consideration (upon application by the taxpayer), e.g., because depreciation allowances on real property are claimed in accordance with section 7 of the Income Tax Act
- employees claim the reduced rate for extraordinary income
The following are credited against the assessed tax:
- any income tax prepayments for the current year according to the tax office’s prepayment notice
- any income tax withheld at source (in the form of wages tax and withholding tax on income from capital/final withholding tax)
If final accounting shows that additional tax is due, the taxpayer must make a final payment of this amount. If current prepayments exceed the tax liability, the excess will be refunded.
Who is liable for tax?
Income tax law distinguishes between limited and unlimited tax liability. Individuals whose residence or habitual abode is in Germany are subject to unlimited tax liability. Individuals not fulfilling the stated preconditions for unlimited tax liability have limited tax liability if they derive domestic (i.e., German) income within the meaning of section 49 of the Income Tax Act (e.g., income from commercial business activity, capital assets or renting and leasing). In special cases, people who are resident abroad may also be treated as having unlimited tax liability.
As a rule, income tax is assessed on a taxpayer’s taxable income in a given year, with assessment taking place after the expiry of that year. Assessment invariably commences with the taxpayer filing an income tax return stating the income he or she has received during the year in question. The tax payable is determined by way of a tax assessment notice. Married couples may elect to be assessed either jointly or separately, provided husband and wife are both subject to unlimited tax liability and are not permanently separated; these conditions must be satisfied either at the start of or at some point during the calendar year. If applicable, they may opt instead for a special assessment during the year in which they married. From 2013 onwards, married couples may opt for individual assessment only (in place of separate or special assessment).
How much is the tax?
The income tax scale (also used to compute wages tax) is the centerpiece of the Income Tax Act. It is the basic determinant of income tax (wages tax) payable by a taxpayer on his or her income. The way in which the basic scale of income tax is built up is essentially determined by the fact that the tax burden must be adapted both to the fiscal needs of the state and, to ensure equitable taxation and for social reasons, to the financial resources of the taxpayer.
It is arranged as follows:
A basic personal allowance is granted on taxable income; the current allowance is €8,354 for individual filers and €16,708 for joint filers.
Tax rates on income in excess of the basic personal allowance increase progressively in two linear ranges, starting at 14% (the basic rate) and rising to 42% (the top rate).
Over the amounts of €52,882 for individual filers and €105,764 for joint filers, any increase in income is taxed at a constant rate of 42%.
A three-percent higher tax rate of 45% is applied to particularly high taxable income (€250,731 and up for individual filers; €501,462 and up for joint filers).
In both ranges with linear progression, the proportion of any additional income taken in tax (the marginal rate) increases in a straight line, although at differing gradients. In the upper proportional zone it remains constant. The extent of the tax burden in relation to total taxable income (the average burden) increases as income rises, approaching the top tax rate for very large incomes.
If income tax (with the exception of wages tax) is withheld at source, flat rates apply in terms of withholding tax.