Income Tax

Definition of Income Tax

Income taxes are direct taxes levied on the income and profits of individuals, companies, and other economic actors. Unlike sales tax, which is levied on a company’s sales, income tax applies to the actual profit a company generates after deducting all costs and expenses. In Germany, these taxes are levied at various levels, including income tax, corporate income tax, and trade tax. Income tax primarily applies to the income of private individuals, while corporate income tax is levied on the profits of companies. Trade tax, on the other hand, applies to business operators such as sole proprietors or owners of partnerships. 

‍The Role of Income Tax in the German Tax System

Income tax is a central component of the German tax system and generates a significant portion of the government's revenue. This revenue is crucial for financing public services such as education, health care, and infrastructure.

The importance of income tax lies not only in generating revenue, but also in its redistributive function. Through progressive tax rates, it helps reduce income inequality, as people with higher incomes pay a higher percentage of their income in taxes. These funds are then used to finance services that benefit society as a whole.

‍Differences Between Types of Income Taxes

The differences between the various types of income tax relate to the tax bases, tax rates, and deductions. The choice of the appropriate type of tax depends on the company's legal form and activities.

• Income Tax: Income tax is levied on the taxable income of individuals and partnerships, such as sole proprietorships, GbRs, and other partnerships. Taxable income is calculated based on revenue and expenses within a calendar year. For employees, gross salary typically makes up the largest portion of income. This may be supplemented, for example, by rental income or non-cash benefits such as a company car. The tax rate is progressive, meaning that individuals with higher incomes pay a higher tax rate. There are tax-free allowances and various deductions that can reduce the tax burden, such as income-related expenses and special expenses. 
• Corporate Income Tax: Corporate income tax applies to corporations such as GmbHs and AGs, as well as cooperatives. It taxes the profits of these companies. Unlike income tax, there is no progressive tax rate. Corporations pay a flat tax rate on their profits. Here, too, there are certain deductions and regulations that can affect the tax burden.  Some entities, such as nonprofit associations, are exempt from this income tax.
• Trade tax: Trade tax is a local tax paid by business operators, regardless of their legal form. It is based on business income and can vary from municipality to municipality. Trade tax is unique in that it is not income-dependent and generally represents the highest tax burden for businesses. However, businesses can utilize a tax-exempt allowance to make a portion of their business income tax-free. The Trade Tax Act (GewStG) governs the amount of trade tax, which varies by municipality.

Income Tax: Tax Rates and Calculation

Tax rates and the calculation of income tax vary depending on the type of income and the total income of an individual or a business. For example, Germany’s income tax system features progressive tax rates that increase as income rises. This means that individuals with higher incomes pay a higher percentage of their income in taxes. 

The exact tax rates may be adjusted from year to year and are set out in income tax tables. For corporate income tax, a flat tax rate generally applies to profits. It is important to note that there are various tax exemptions, deductions, and tax breaks that can affect the actual tax burden. Correctly calculating income tax therefore requires a thorough understanding of current laws and regulations, as well as careful bookkeeping and tax planning.

Sample Calculation for Income Tax

To calculate income tax for individuals, income from the categories defined in Section 2(1) of the Income Tax Act (EStG) is aggregated. These include, for example, income from self-employment and income from capital assets. The total income is then reduced by the senior citizen tax relief amount, deductible losses from previous years, special expenses, and extraordinary burdens. In addition, tax-exempt allowances are subtracted; these vary in Germany depending on one’s life situation and marital status. For example, the annual basic tax-exempt allowance for single individuals is 10,908 euros in 2023. Income below this threshold is not subject to tax. If income exceeds this threshold, only the amount above the tax-exempt allowance is taxed.

If a single person earns 50,000 euros gross per year and there are no special deductions, such as extraordinary expenses, the taxable income is 50,000 euros – 10,908 euros = 39,092 euros. According to the income tax table, the tax rate for income between 16,000 euros and 62,809 euros in 2023 is 24 percent. The income tax is calculated as follows:

39,092 euros × 25 percent = 7,273 euros

Calculation Example for Corporate Income Tax, Including Trade Tax

The corporate income tax rate in Germany is 15 percent. In addition, there is a solidarity surcharge of 5.5 percent. Corporations subject to corporate income tax are also generally subject to trade tax. Trade tax is applied at different assessment rates depending on the federal state. In Berlin, for example, the trade tax assessment rate has been 410 percent since January 1, 1999. 

If a Berlin-based GmbH generates a pre-tax profit of 250,000 euros in 2023, the 15 percent corporate income tax amounts to 37,500 euros. The solidarity surcharge, which is 5.5 percent of the corporate income tax, amounts to 2,062.50 euros. In total, the corporate income tax and solidarity surcharge amount to 39,562.50 euros. 

The trade tax is calculated based on a taxable base of 250,000 euros, a flat rate of 3.5 percent, and a trade tax multiplier of 410 percent. In this case, the trade tax is calculated as follows:

250,000 euros * 3.5 percent * 410 percent = 35,875 euros

In total, the GmbH must therefore pay 39,562.50 euros + 35,875 euros = 75,437.50 euros in corporate and trade tax.