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The ins and outs of income tax

The Local · 3 Nov 2011, 07:01

Published: 03 Nov 2011 07:01 GMT+01:00

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If you live in Germany with the intention of staying at least six months you will be considered a resident and have to pay income tax. Just how much tax will fall into the clutches of the Finanzamt will depend upon a variety of factors, including whether you are married or not and how many children you have. Unlike in other countries such as Britain, the tax year in Germany matches that of the calendar year.

If you work as an employee in Germany, managing your taxes is not such a burden. Employees automatically have their income tax deducted from their monthly salary. Single people earning an annual taxable income less than €8,000 are exempt from tax while married couples earning less than €16,000 a year also do not have to pay tax on their income. A sliding scale, marginal tax rate is levied on anything higher.

A single person in 2010 on an annual income of €8,000 paid a marginal tax rate of 15.8 percent, rising to 19.5 percent at €11,000, 24.7 percent at €15,000, 27 percent at €20,000, 31.5 percent at €30,000, 36.1 percent at €40,000 and 42 percent at €60,000.

High net-worth individuals with an income of €500,000 or more pay the top-rate tax of 45 percent.

An income tax burden can be reduced via a variety of tax deductions, including certain types of insurance premiums, political contributions, donations to charity and expenses incurred in extraordinary circumstances such as illness. Children under the age of 18 or young people under the age of 27 attending college without earnings are also eligible for deductions.

Sonderausgaben [private expenses] can be deducted. For example, pension insurance policies and health insurance policies, which is very important. Health insurance is often for a freelancer about €250 a month. You can also deduct doctor costs – but they would have to climb over a reasonable burden – child care costs and other costs such as extraordinary expenses, that are mostly in the private area,” explained Matthias Gust of Gust & Martini, a tax advisory firm based in Berlin.

The Lohnsteuer, a wage tax which forms part of the Einkommensteuer (income tax), is collected at source and paid directly to the Finanzamt by an employer. Germany has two categories of employees: formal employees, who are obliged to pay a salaried wage tax, and those obtaining their salary from an employer based in another country. In this case, the salary is surcharged from a foreign entity to a German entity once the salary has been paid to the employee. “If a foreign employer cross-charges salary to a German employer, the German employer is obliged to withhold wage tax on behalf of the expatriate,” said Michael Kemper, a tax partner at Ernst & Young in Stuttgart.

Tax classifications

Germany uses a classification system to determine a salaried employee’s tax burden. Almost all single taxpayers without dependants will be put in Steuerklasse I. Married couples with one primary earner, however, can lower the amount of tax deducted from their wages by selecting a combination of Steuerklasse III/V. This is usually beneficial for those filing a joint return using the Ehegattensplitting procedure, which splits the combined income of the couple in two equal sums and can lower the primary earner’s overall tax bracket.

Germany is currently in the process of replacing its antiquated paper wage tax cards (Lohnsteuerkarte), which contain information such as a person’s tax class and child deductions, with an electronic version. Going by the clunky German abbreviation ElStAM for Elektronische Lohnsteuerabzugsmerkmale, it is supposed to mean less paperwork for both employers and the tax office. Employees can also control some degree of how much personal information their company can access – such as whether they have recently married.

And unless you are keen on state-organized tithing, be sure to opt out of your church tax known as Kirchensteuer, which can cost up to nine percent of your wages.

Unlike countries such as the United Kingdom and the United States, Germany does not have a self-assessment tax system. Those who are self-employed (selbständig) or obtain rental income from a property or investment income fall under the Einkommensteuer. While the Lohnsteuer is collected at source and paid directly to the tax office by an employer, those liable for Einkommensteuer are responsible for paying their taxes themselves.

Taxpayers filing income tax under the Einkommensteuer rules will have their tax return computed by the Finanzamt. Items on a tax return may be questioned by the tax office and require follow-up correspondence such as supporting documentation for deductions.

The Finanzamt automatically calculates a person’s tax burden, based upon their earnings in the previous year. The benefit of this is that during the tax year there is not a need to provide the tax office with any details of income. If a taxpayer has a lower – or higher income – than the previous year he or she can apply for a reduction – or increase – in the amount of tax liable to be paid.

Paying in advance

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Taxpayers are required to make prepayments (Vorauszahlungen) normally on a quarterly basis on March 10, June 10, September 10 and December 10. The total amount of tax liable to be paid will be calculated after an income tax return is completed, which includes all sources of income. Wage tax withholding as well as provisional payments are deducted from this total tax liability so that a refund or final tax payment is assessed.

Once a tax return has been filed, a tax assessment is usually issued by the Finanzamt between one and six months afterwards. No payment will be due before the Finanzamt registers receipt of the tax assessment notice. An income tax return (Einkommensteuererklärung) should be filed by May 31 of the year after the one in which the income was obtained.

“The only advice for expats should be to look for a tax consultant, particularly if they still have a foreign income. In Germany there are a lot of possibilities for applying for reductions in a tax bill. You have to know them,” said Kemper of Ernst & Young. “Those on a self-employed basis who still have rental or investment income from other countries, will have to look at the double tax treaty in order to know if it is tax exempt in Germany.”

In some cases, expats with a foreign-sourced income may have to pay tax even though the income is less than the personal allowance threshold. “An expat with a low income of €7,000 who obtains a higher income in another country will have to include this in their tax return. The effect could be that he or she loses the €8,000 tax-free allowance and there could still be tax to pay,” said Kemper.

Those who enlist the services of a tax consultant obtain an automatic extension and have until September 30 to file their return. Tax returns filed after these two cutoff dates can incur penalty interest rate payments. A tax adviser will be able to obtain a further extension until December 31 on behalf of a taxpayer by filing an individual extension.

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Your comments about this article

10:25 November 3, 2011 by heathen
Heike Muller: editor of Spielkunst Magazin, boyfriend Dieter is host of TV show 'Sprockets' where guests are invited to touch his monkey.
10:30 November 3, 2011 by Englishted
Don't bother send it straight to the E.U. and they will enjoy themselves with it.
10:36 November 3, 2011 by frankiep
Doubly difficult for US citizens in Germany who have to file German taxes AND file a return with the IRS in the US.
11:50 November 3, 2011 by jg.
Apart from the Finanzamt (like German banks) sending me letters in language which I need to have decoded by an expert, I find them fairly straightforward. They have never given me any problems, even when I have been a little late with some submissions. It is quite refreshing when compared with UK tax officials, where staff bonuses for tax collected can lead to some unreasonable and unpleasant behaviour.
21:28 November 3, 2011 by drdoom
My experience is very unpleasant. I earned one year taxable salary - six month in 2009 and six months in 2010. I signed the forms and gave all the documents to tax auditor. At the time my auditor promised I will get few thousand Euros at least. Still I have not got anything back. If this is frustrating, I am still having my bank a/c open and I have to pay service charge for it. Worst is mobile phone. Vodafone took money from my account for one year after I left Germany. This is despite my repeated request to cancel my account stating my departure from the country.

My suggestion is simple. If you are leaving Germany, do not expect anything as tax return. Just fill tons of paper and leave the country after CLOSING your bank account.
15:29 November 5, 2011 by murka
If you are a business in Germany, be prepared to hire an account from day 0, even with no income on the horizon. Obscurity of German "Finanzverwaltung" results in effectively a flat tax (wage of the first accountant) on start-ups and small businesses. If you have employees, it gets even worse. After few years into the business you may discover that your paperwork was wrong and needs to be redone from scratch. Speaking from personal experience.
19:00 November 5, 2011 by ChrisRea
@ murka

I hope it was not you to start a business without an income on the horizon. It would make you a terrible entrepreneur. I also hope that you did not hire an accountant with a low fee, because that is also a lousy move. This is valid not only in Germany, but in many countries if not all.
20:18 November 5, 2011 by murka
@ ChrisRea - unfortunately it is typical in hi-tech - first years are R&D, eating away the initial investment, no income. I witnessed a few start-ups in different legislations, and the German paperwork overhead was the most abhorrent of all. An example: I was shocked to learn that in the U.S. (FL) no communication with tax authorities is required during the financial year (at least in my particular setup and as long as no substantial profit is generated). Annual filings only!

As to you second question: no, it was an experienced German accounting firm, with decades on the market, who made a mistake in a slightly off-the-beaten-path situation.
07:24 February 16, 2012 by camilleH
I'm not really into taxes but I encounter an article recently stating that a married couple is recognized as a single entity. The IRS thinks this is the case also. That said, once a couple has gotten hitched they must decide whether to file separately or together. I guess this is a very good way to let the couple start as one not separately and it may also helps strengthen their bond as a couple. You may also read more regarding this issue on paying taxes by couples in this article here: [url=https://personalmoneynetwork.com/]Newlyweds of 2011 have to weigh filing individually or jointly.
15:32 April 5, 2013 by Rombacher
One good thing many foreigners don't know: Unlike in the US there are many cases when you will not need to file a German tax return at all. E.g. Singles with only work and German capital income are not required to file a tax return. However, in case you had substatial work related cost (like moving cost to Germany, double house hold) a tax return might give you a big tax saving. More info on deductible costs can be found here: http://www.fmt-tax.com/en/themen/checklist-german-income-tax-return/
11:59 August 30, 2013 by Cassandra03
People have to pay federal income tax on their Social Security Benefits, this usually happens only if you have other substantial income (such as wages, self-employment, interest, dividends and other taxable income that must be reported on your tax return) in addition to your benefits. Health benefit claim payments are non-taxable, disability claim payments are non-taxable if all employees covered by the insurance policy have always paid the full cost of their premiums and related taxes through payroll deductions, and retirement income benefits are taxable when received by employees.
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