The new tax year has started with the government having introduced a series of key changes, which you will need to know when compiling your returns. In his first of a regular Expatica column, our tax accountant Martin Brune takes us through the changes and tells us what to look out for.

Let’s start with the changes in German social security: Like every year, the annual income ceilings have been amended. The annual income ceiling is the maximum amount on which the social security contributions are calculated. Amounts above this annual income ceiling means you are not required to make social security contributions.

As of the start of the year, the annual income ceiling for pension and unemployment insurance increased from EUR 61,800 to EUR 62,400. The annual income ceiling for health and care insurance increased from EUR 41,850 to EUR 42,300.

Facing up to a string of tax changes

Following a recent decision handed down by the Federal Constitutional Court (Bundesverfassungsgericht), people required to make welfare contributions with children are to pay a lower contribution towards care insurance (in the event of illness or old age) than people without children. As a result, parliament agreed to legislation modifying the contribution scheme of the care insurance effective from the beginning of 2005.

Also starting 1 January 2005, childless people older than 23 years have to contribute 1.1 percent of their salary (up to the income ceiling) as a care insurance contribution, whereas for people who have at least one child the contribution rate remains at 0.85 percent. But regardless of the employees' rate, the employers' contribution remains at 0.85 percent

Insured people with children need to inform their health insurance company that the lower rate is applicable to them. 

Final round of tax cuts introduced

The good news for 2005 is that the income tax burden has fallen with the start of the year.

Based on Chancellor Gerhard Schroeder's 2000 tax reform plan the top marginal income tax rate of EUR  52,152 (single)/104,304 (married) has been reduced from 45 percent last year to 42 percent this year.
 
The general tax free amount has remained at EUR 7,664 (single)/EUR 15,328 (for married couples filing jointly). At the same time, the starting progressive income tax rate above the general free amount was reduced from 16 percent (2004) to 15 percent (2005).

Who benefits?

Although the tax rates 2005 are lower than 2004, some of the savings will be eaten up by the changes to social security contributions

An investigation conducted by DATEV, the software cooperative of German tax advisers, showed that childless people with a lower income may even have a lower amount in their pocket than in 2004.

Taxpayers with children and taxpayers with a monthly gross income of EUR 3,000 (single)/ EUR 5,000 (married) or above will benefit from the new rules and will have a higher net in their pockets.

Impact on pensions

Also on 1 January 2005, the “Alterseinkünftegesetz” (law regulating the taxation of pensions and pension expenses) came into effect. It has a considerable impact on all kinds of statutory, occupational, and privately funded pension plans.

As required by the Federal Constitutional Court pensions paid out from the state's pension scheme and civil pensions will be treated as equal for tax purposes. In the future, following this decision, pensions received from the state pension scheme will be fully taxed, whereas contributions to a pension plan or the government pension scheme will be left tax free up to certain amounts.

During the transitional period from 2005 to 2040, the main key points of the “Alterseinkünftegesetz” are:

Employees and employers contributions to government or private pension plans are tax deductible up to EUR 12,000 a year in 2005. This amount will increase by EUR 400 each following year, so that by 2020 a maximum amount of EUR 20,000 a year will be tax deductible.

On the other hand, 50 percent of proceeds from life annuities will be taxable in 2005. This rate will increase gradually every year until 100 percent is taxable in the year 2040.

Tax changes for life insurance plans

Proceeds from life insurance policies concluded after 31 December 2004 are no longer tax free even if the contract is concluded for more than 12 years. If the duration of the contract is at least 12 years and the payout is at age of 60 or more, only 50 percent of the proceeds will be taxed. Otherwise, the full amount will be taxed in the year the payment is made.

Life insurance contracts concluded before the new rules became effective (that is, before 1 January 2005) will be treated according to the previous tax arrangements. In this case, proceeds could be tax free if certain conditions are met.

The tax arrangements for employer-provided life insurance have also changes. Up until the end of 2004, employer-provided life insurance policies were subject to a flat rate tax. But contracts signed after 31 December 2004, the contributions will be entirely tax-exempt. Moreover, the pension payments out of these contracts will be taxed in full.

Since the start of 2004 people are also required to pay health insurance on the payments from life insurance policies. This might lead to an increase of health insurance contributions if the beneficiary is insured with a public health insurance company.

Online tax declarations

The German tax office has also undergone something of an online revolution in 1005.

Indeed, starting in 2005 VAT and wage tax declarations need to be submitted to the tax authorities electronically only.

For this reason the tax authorities have developed software called “ELSTER” (named after a thievish bird – Elster means magpie). It is included in the normal German bookkeeping software or can be downloaded.

However, declarations lodged covering the period until 31 March 2005 will not be rejected if they are filed in a traditional way (paper or fax).  After 31 March an application for exemption can be filed if the necessary computer equipment or if an internet connection are not available.

Tax amnesty

With the beginning of the New Year only three months remain to file a declaration according to the amnesty tax law.

If taxpayers declare taxable income that was not included in the tax return for 2002 or the years until 31 March 2005 and subsequently pays the tax until this date, they will be exempt from a fine or possible jail sentence.

Besides the exemption from a fine or jail sentence those who have failed to pay tax punishment tax offenders also probably benefit from a lower tax burden: A flat tax rate of 35 percent (in 2004: 25 percent) is calculated on a reduced assessment basis.

__________________

To read more about Martin Brune you can click on Ask our accountant  or Financial - Advisors under Expatica's business directory.

This article contains information of a general nature and should not be considered as legal advice.

Although the greatest care has been taken in drafting this article, it is possible that certain information may have become outdated or inaccurate since its publication. Martin Brune cannot be held liable for the consequences of actions or omissions based on the content of this article.

January 2005

Send a question to Martin Brune at germany@expatica.com

[Copyright Expatica 2005]

Subject: Life in Germany, tax advice, ask our accountant