Income tax in Germany for entrepreneurs

Income tax in Germany for entrepreneurs

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If you own a company or work freelance in Germany, here's a guide to personal tax liabilities for self-employed workers in Germany.

For individuals carrying on business activities, the same general principles for determining industrial, commercial, agricultural and professional profits apply as for corporate entities. The taxable profit is the total income realised from carrying on business activities, and includes the distributed profit shares of general and limited partnerships, as well as profits earned by sole proprietors.

Under the Income Tax Law, a business is defined as any independent and lasting activity exercised with the intention of earning profit by participating in the open market and which does not qualify as professional or agricultural or forestry activities.

Taxes on business income in Germany

Municipal business tax is levied on all business enterprises in Germany, regardless of their legal form. Individuals are also liable for municipal business tax on their business. The business tax is levied on a taxpayer's business income. The municipal business tax is a lump-sum tax, which may be credited against income tax.

The taxable income for the business tax is generally determined in the same manner as for income tax purposes, subject to certain adjustments. These adjustments refer to certain expenses, which may be deducted for income tax purposes but not for business tax purposes and vice versa. A personal exemption of EUR 24,500 is granted to individuals and partnerships.

The effective rate of business tax depends on a federal rate (Steuermesszahl) and a municipal coefficient (Hebesatz). The amount of business tax is determined by applying first the basic federal rate to the taxable business income, which results in a basic tax amount. The coefficient is then applied to this basic tax amount to determine the actual tax burden. The coefficient is fixed by the municipalities and may vary according to their financial needs from 200 percent to 490 percent.

The effective tax rate varies from community to community but averages 14 percent to 17 percent of income.

The taxpayer is entitled to a credit calculated as 3.8 times the basic amount for the municipal business tax. The credit is subject to a maximum that is determined by the proportion business income bears to all taxable income.

For example, if a taxpayer earns 55 percent of his taxable income from employment, runs a business that provides the remaining 45 percent of his taxable income, and has an income tax liability of EUR 50,000, the maximum business tax credit is EUR 22,500 (45 percent of EUR 50,000).

Any excess credit cannot result in a refund of income tax, nor may it be carried over to be set against income tax of another year. Despite this limitation, the municipal business tax credit may result in overcompensation depending on the municipal coefficient when the tax credit is greater than the municipal business tax and the taxpayer can use the credit fully against his income tax liability for the year.



Dorine Fraai / Expatica

Dorine Fraai specialises in international tax planning for both individuals and companies.
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