Income Tax in Germany: Part 2

Subject to certain conditions, expenditure for the support and vocational training of another person may be deducted to a limited extent as an extraordinary financial burden; in addition, certain persons may claim lump-sum amounts. These cases are as follows:

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• Expenditure for the support and, as the case may be, the vocational training of a person legally entitled to receive support from the taxpayer or his/her spouse and for whom neither the taxpayer nor any other person may claim the tax-free allowance for children or child benefit if the dependent person has no or only a small amount of assets, maximum €15,500. Expenditure of up to €8,004 a year is deductible. Contributions to basic health and statutory long-term care that are made for the dependent person increase the deductible amount insofar as the contributions have not already been taken into account as ‘special expenses’. A status equivalent to that of the legally dependent person is accorded to a person in respect of whose support certain domestic public funds are reduced in accordance with the support payments made by the taxpayer. Any net income and in principle, any earnings accruing to the supported person exceeding a total of €624 are to be off set against the amount of €8,004. The same applies for grants that the dependent person receives to finance training where the grants come from public funds or from institutions receiving public funds for this training purpose.
• Expenditure of up to €924 a year for the special needs of a child who is undergoing vocational training and lives away from home, and for whom the taxpayer is entitled to claim the tax-free child allowance or child benefits.
• People with disabilities are entitled to deduct a lump-sum amount ranging from €310 to €7,200 a year, depending on the extent and type of their disability. If it can be shown that they have incurred certain higher expenditure resulting directly from their disability, this expenditure may be deducted as an ‘extraordinary financial’ burden instead of the lump sum disability allowance, taking account of the burden they may reasonably be expected to bear themselves.
• Surviving dependants are entitled to claim a lump sum allowance of €370 a year.
• Taxpayers who themselves look after a dependant relative in their own home or that of the relative may claim a lump sum care allowance of €924 a year, provided they do not derive any income from long term care insurance.

The taxable income determined in this manner forms the basis for the assessment of income tax according to the tax scale. This amount of tax constitutes the assessable income tax with the amount reduced by credits for foreign taxes paid and any applicable tax relief, for example, for expenditure on employment or services in or around the household and increased by certain amounts, including the entitlement to child benefit if tax-free child allowances have been deducted from taxable income because child benefits paid were not sufficient to effect the tax exemption stipulated in the constitution.

Employees are required by law to submit an income tax return in particular cases. In other instances, income tax will only be assessed under certain circumstances, if;

• The taxpayer applies for assessment, especially to credit wages tax and withholding tax on income from capital, final withholding tax
• Either spouse applies for separate assessment or both spouses apply for special assessment during the year in which they married
• A loss from income other than that derived from employment has to be taken into consideration upon application by the taxpayer, for example, depreciation allowances on real property are claimed in accordance with the Income Tax Act
• Employees claim the reduced rate for extraordinary income

The following are credited against the assessed tax;

• Any income tax prepayments for the current year according to the tax office’s prepayment notice
• Any income tax withheld at source in the form of wages tax and withholding tax on income from capital/final withholding tax

If final accounting shows that additional tax is due, the taxpayer must make a final payment of this amount. If current prepayments exceed the tax liability, the excess will be refunded.

Income tax law distinguishes between limited and unlimited tax liability. Individuals whose residence or habitual abode is in Germany are subject to unlimited tax liability. Individuals not fulfilling the stated preconditions for unlimited tax liability have limited tax liability if they derive domestic, i.e., German, income within the meaning of section 49 of the Income Tax Act, for example, income from commercial business activity, capital assets or renting and leasing. In special cases, people who are resident abroad may also be treated as having unlimited tax liability.

Taxable Income

In most cases, income tax is assessed on a taxpayer’s taxable income in a given year, with assessment taking place after the expiry of that year. Assessment invariably commences with the taxpayer filing an income tax return stating the income he or she has received during the year in question. The tax payable is determined by way of a tax assessment notice. Married couples may elect to be assessed either jointly or separately, provided husband and wife are both subject to unlimited tax liability and are not permanently separated, these conditions must be satisfied either at the start of or at some point during the calendar year. If applicable, they may opt instead for a special assessment during the year in which they married. From 2013 onwards, married couples may opt for individual assessment only in place of separate or special assessment.

If married couples elect to be assessed separately, each spouse is assessed on his or her income. Amounts deductible as special expenses are attributed to the spouse incurring them. Any eligible extraordinary burdens and tax relief for expenditure on employment/ services in or around the home are halved and one half deducted from the income of each spouse, unless the spouses opt for a different division. This assessment is made according to the income tax scale.

In the case of joint assessment, the net incomes accruing to each spouse are aggregated and the couple treated to all intents and purposes as a single taxpayer. Income tax is then determined using the income splitting method, with tax being computed according to the income tax scale on half of the joint income, and the result being doubled. Tax calculated in this way is generally lower than the amount that would have arisen if the couple had filed separate returns.

In the case of special assessment during the year of marriage, the couple are treated for tax purposes as if they had not entered into the marriage. In the case of the option available from 2013 for married couples to be assessed individually, special expenses, extraordinary burdens and tax relief for expenditure on employment/services in or around the home will be credited to the spouse paying the costs. If the couple makes a consensual request, half will be deducted per person.

The income tax scale, also used to compute wages tax, is the centrepiece of the Income Tax Act. It is the basic determinant of income tax, wages tax, payable by a taxpayer on his or her income. The way in which the basic scale of income tax is built up is essentially determined by the fact that the tax burden must be adapted both to the fiscal needs of the state and, to ensure equitable taxation and for social reasons, to the financial resources of the taxpayer.

It is arranged as follows:

• A basic personal allowance is granted on taxable income; the current allowance is €8,004 for individual filers and €16,008 for joint filers, and will be raised to €8,354 and €16,708, respectively, from 2014 onwards.
• Tax rates on income in excess of the basic personal allowance increase progressively in two linear ranges, starting at 14%, the basic rate, rising to 42%, which is the top rate.
• Over the amounts of €52,882 for individual filers and €105,764 for joint filers, any increase in income is taxed at a constant flat rate of 42%.
• A three-per cent higher tax rate of 45% is applied to particularly high taxable income of €250,731 and up for individual filers and €501,462 and up for joint filers.

In both ranges with linear progression, the proportion of any additional income taken in tax, the marginal rate, increases in a straight line, although at differing gradients. In the upper proportional zone it remains constant. The extent of the tax burden in relation to total taxable income (the average burden) increases as income rises, approaching the top tax rate for very large incomes.

If taxable income includes extraordinary income, rate concessions may be claimed to avoid hardship that might otherwise be caused by progression. This applies in particular to income that accrues once only, such as compensation payments, proceeds from the sale of a business and certain income from an activity lasting over several years. Dividing the extraordinary income, to be given relief, by five and multiplying the tax payable on that portion by five gives the rate concession.

If income tax, with the exception of wages tax, is withheld at source, flat rates apply,

• Withholding tax on income from capital
• Final withholding tax
• Withholding tax on the income of non-residents

The legal basis for taxing individual’s income is provided by the applicable versions of the Income Tax Act and the Income Tax Implementing Ordinance. In addition, the Federation has issued income tax and wages tax guidelines, in the form of general administrative regulations with the consent of the Bundesrat, that are designed to clarify uncertainties and questions of interpretation.

The Länder administer the income tax.

The importance of income tax in Germany’s taxation system is demonstrated when its receipts are compared with total tax revenue and GNP. In 2010, revenue from income tax, including revenue collected in the form of wages tax and final withholding tax, which are special forms of income tax collection, amounted to €1675.8bn, accounting for 31.6% of total tax receipts, which were at €530.6bn. Income tax is thus the public authorities’ most substantial source of revenue.

The taxpaying capacity of each individual is taken into account by making allowance for specific material and personal circumstances. Increasingly, income tax is also used to achieve economic, social and related policy objectives. Besides the arrangements in the Income Tax Act, these tax measures are regulated in separate laws.