Merkel's left-right coalition said it had agreed a proposal that would allow employees working from home to reduce their annual tax bill by per €5 working day, up to a maximum amount of €600 per year.
Finance Minister Olaf Scholz said the proposed legislation, expected to be approved by parliament in December, is “good for workers” and “not a big fiscal challenge for the German state”.
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Tax law in Germany means that working from home normally only qualifies for rebates if one room in the house is used exclusively as an office.
But with millions of office employees working from their living rooms and kitchen tables to reduce the risk of Covid-19 transmission, calls have grown for the rules to be relaxed.
Calculations by the Ifo institute show that around 56 percent of German employees could potentially work from home temporarily.
Existing law “no longer correlates to today's working world,” said Sebastian Brehm, an MP and tax advisor for Merkel's CSU Bavarian sister party.
The planned tax deduction was the “flexible answer” to this, he told AFP.
What remained unresolved however was whether the home-office tax proposal would be included in the 1,000 euro tax deduction every German employee already gets annually for job-related expenses like transport and work outfits, or whether it would come on top of it.
This year's massive shift to working from home to reduce the risk of Covid-19 transmission is likely to lead to changes in the workplace that will outlast the pandemic.
Labour Minister Hubertus Heil has already said he wants employees to have the right to request to work from home occasionally in future, though he backed down from an initial proposal of guaranteeing workers at least 24 days of home office a year.
Last week, Germany's largest lender Deutsche Bank said it was mulling allowing employees to work away from the office permanently for two days a week, according to Bloomberg News.