Taxation in Germany

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Taxation is one of the most criticized matters in Germany. Germans themselves assume that it is the most complex system in the world. Ten percent of the literature on taxation in the world refers to the German tax system. There are 118 laws, 185 forms, 418 exceptions and 96,000 regulations (just one comment to taxation covers 2,671 pages). There are nearly 100,000 instructions for the administration only referring to taxation (more than 28,000 pages). The complexity of the German tax system is a result of constant modifications prompted by political and corporate pressure groups.

Administration costs amount to an annual €3.7 billion for levying income taxes, which is approximately two and a half per cent of the total amount of income tax yielded every year (€150 billion).

Since tax regulations are frequently modified and hard to understand, people rely on tax advisors.

Contents 1 Tax use 2 Business Taxation 3 Individual Taxation 3.1 Categories of the Individual 3.2 Wage Tax, Solidarity Tax, and Church tax 3.3 Social Insurance 3.4 Individual Taxation Example 3.5 Freiberufler Taxation Example 4 See also 5 External links 6 References

[edit] Tax use

In 2006, the federal government plans to spend a total of 262 billion Euro, which include 38 billion Euro in new debts (as a percentage of the taxes go to the states, this is not the total amount of taxes). Of these, the five largest items are work and social welfare (120 billion Euro), payments for existing debts (40 billion Euro), defense (24 billion Euro), traffic (24 billion Euro), salaries and pensions for federal employees (8.5 billion Euro), and sciences (8 billion Euro).

[edit] Business Taxation

Despite its image, taxation of corporations in Germany is only nominally high, but tax revenue is effectively low to non-existent. Corporations have to pay a certain percentage of earnings as tax. But the ways in which costs can be deducted from tax are numerous and powerful. After the tax reform of 2000 the corporate tax revenue sharply declined. All four corporate taxes (Körperschaftssteuer, Kapitalertragssteuer, veranlagte Einkommenssteuer, Gewerbesteuer) taken together have yielded only € 23.6 billion in 2000, minus € 0.4 billion in 2001 and € 2.9 billion in 2002. Considering the size of the German economy and the record high earnings of German blue chips this situation is nothing short of preposterous to ordinary Germans.

Small businesses, however, struggle with the high nominal taxation, as they are often unable to utilize the numerous loopholes. Also, freelancers and entrepreneurs run into this problem. If their profits must be predominantly used for living expenses on a regular basis (rather than saving profits for more than a ten year period), there is no way the money can be saved from the high nominal taxes.

An example should illustrate this. A wealthy businessman lives off his bank interest and can reinvest 90% of his profits according to the tax deduction rules. He does so for 10 years in a row. After 10 years he owns several times as many semis, buildings, land and so on than before. Some of his investments may decline in value, but others don't. As he has kept his business for 10 years plus, he does not have to pay corporation sale tax. So he sells it for a fortune. In sum he has almost not paid any tax during operation and nothing when selling the company. Though he made millions of euros, his employees paid more tax than he did.

[edit] Individual Taxation

Germany's individual tax rates vary with the income, that is the tax rates are progressive as they are in most industrialized countries of the west. On salaries and wages, income taxes are paid as you earn. Income taxes have been reduced recently, and the maximum marginal rate is 42% in 2005.

By law, employees pay "as they earn" a compulsory fee for their individual social security of approximately 20-21% of what they earn. The same amount is paid by the employer into the bargain, which is a continual contentious political issue in Germany.

[edit] Categories of the Individual

In Germany, for tax purposes you can either be a resident or a non-resident. If you have been present in Germany for over 183 days in the last year, you are generally considered to be a resident for tax purposes. The 183 day rule is not the only consideration for tax residence (see your embassy's website or talk to a tax consultant or accountant).

If you are a non-resident for tax purposes (for instance a short term contractor), you will generally still be liable to pay tax on German-sourced income. The rate may vary; tax and double taxation agreements may alter it.

There are 6 tax classes that you may fall into, each one with varying rates:

1. Those single or separated, but not falling into either categories 2 or 3.
2. Single and separated, with a child, entitling them to a child's allowance.
3. Married, or widowed employees who are within the first year of a spouse's death.
4. Married employees both receiving income.
5. Married persons who would normally fall into category 4, but whose spouse is in tax class 3.
6. Employees who receive income from other employment on one or more different tax cards.

On top of this, you may either be a salaried employee (as most people are) or a Freiberufler (free professional, for instance doctors, architects, or contractors). For salaried employees, tax and social insurance are withheld by the employer. Contractors must pay the tax department their tax obligations regularly throughout the year.

[edit] Wage Tax, Solidarity Tax, and Church tax

Wages are taxed in 3 separate linear progressive ranges. In 2005, the ranges are as follows for a tax class 1 resident individual:

• Tax Free Allowance of €7,664.00
• Linear progressive zone from 15% to 24% on taxable income from €7,665.00 up to €12,739.00
• Linear progressive zone from 24% to 42% on taxable income from €12,740.00 up to €52,151.00
• 42% of all taxable income after €52,152.00

Solidarity tax is levied for the purpose of supporting the economy of the former GDR and is calculated at 5.5% of your wage tax.

Church tax is only relevant if you listed a religion on your tax form. It will be either 8 or 9% of your wage tax.

[edit] Social Insurance

Regular employees are liable for the following individual social insurance: Health insurance, pensions insurance, unemployment insurance, and health/nursing care insurance.

Health insurance is 6% - 7% of taxable income (before tax, minus deductions). Pensions insurance is 9.65 %, unemployment insurance is 3.25 %, and health/nursing care insurance is 0.85% of taxable income. In total, this is around 21% of your taxable income. These payments are partly subject to a tax relief or tax deductions. Employers have to pay the same amounts that go into the social security of the individual employee.

German pensions are currently not taxable at retirement age. If the earnings of an employee are above a certain limit (about €46,800 in 2005), he or she can opt for a private health insurance policy, which can be considerably cheaper, especially when the employee is young and unmarried. The national health system is a family insurance, covering spouse and children. Private insurance covers children, until they work themselves (and therefore fall into the mandatory public insurance)

A freelance professional, Freiberufler, is not at all lawfully obliged to take out social insurance policies.

Tax payers are entitled to a reduction of about €2,100.00 in taxable income for social insurance.

[edit] Individual Taxation Example

• You are offered an employee position at €35,000.00 per year.
• You take deductions of €3000.00 for various deductible expenses (including insurance reduction of about €2,100.00, your contribution being over)
• You pay €7,041.65 in social insurances (34100 * 0.2065)
• You are liable for €6,634.00 wage tax (based on €32,000.00)
• You are liable for €364.87 solidarity tax (5.5% of €6,634.00)
• You aren't liable for church tax.
• You have a net yearly income of €20959.00 (€1746.58/month, €401.68/week)
• The company pays €7,041.65 in social insurances, matching your contribution.

With appropriate forms, you may be able to contribute to social security insurance or pension funds in your home country, up to a maximum period of 5 years.

[edit] Freiberufler Taxation Example

This will be calculated based on year-end calculations. Actual calculations will vary considerably, as you'll probably pay more tax while working and get a refund from the tax department later.

• You take a 9 month contract at €350 per day (Let's say 190 working days), and then take a 3 month holiday.
• €350 * 190 = €66500.00
• You claim €5300 tax-free (second apartment, car/travel, other business expenses)
• You pay €1200.00 for almost-comprehensive Germany-only yearly private health insurance, and claim it back tax free (under the around €2100 insurance allowance)
• You pay €18,155.00 in wage tax.
• You pay €999 in solidarity tax.
• You are left with €39646.00 + €5300 in the year.

It might be wise to take up some other insurance, also, such as permanent disability, life insurance, or pension insurance. You are allowed around €2100 in insurance deductions per year, so it's not a great loss to make the most of it. With the appropriate forms, you can contribute to social security funds in your home country.

Depending on your type of work, you may not be classed exactly as a Freiberufler, and you will be subject to trade tax (Gewerbesteuer), which is a tax calculated with a region-dependent multiplier on your existing tax obligation. This varies between around 10% and 16% of your existing tax bill, depending on where you are. For example, if you pay 18,155 in wage tax, you will also be taxed €2,904.00 in trade tax if you live in Munich.

[edit] See also

• Taxation in the United Kingdom
• Taxation in the United States

[edit] External links

• German Embassy London's Living and Working in Germany Section
• Contractor UK - IT Contacting in Germany
• MySME Information for foreign SMEs in Germany (In English)
• Freiberufler Information (In German)(English Auto-Translation)
• Freiberufler Community (In German)
• Yahoo's Comprehensive Wage & Net Income Calculator (In German)
• German Income Tax calculator for 2006 (In English)
• German Wage Tax calculator for 2006 (In English)

[edit] References