Understanding the German Tax System as an Expat

Germany is a hub of opportunities. Every year, thousands of expats move to the country to get the benefit of work opportunities and to pursue a better lifestyle. Even though there could be numerous advantages of moving to Germany, certain bureaucratic aspects of relocating to Germany cannot be overlooked with the German tax system being the most complex and challenging. Since paying taxes is a legal obligation for everyone living and earning in Germany (regardless of their citizenship status), it is crucial to have a thorough understanding of the taxation in Germany for expats . 

As an expat, if you’re planning to stay in the country for more than 6 months, you have to pay taxes as per the German tax system. So, if you’re moving to Germany or planning to work in the country, it is important to understand how taxation in Germany works in order to avoid any legal or financial consequences.

German Tax Category

Like other Western countries, the German tax system also works by requiring individuals to pay income taxes throughout the year, typically the employer deducting taxes from each paycheck. Expats living in Germany have to pay German taxes if they are earning any type of income in Germany. The German tax system consists of several taxes, including income tax, social security contributions, solidarity tax, Value-added tax (VAT), and church tax.

Here are some of the most common categories of taxes in Germany:

1. Income Tax: This is a tax based on the income earned by individuals and/ businesses. Income tax in Germany is calculated on the progressive rates and is based on the income. That means, if you earn more, you will pay tax at a higher rate. 
2. Value Added Tax (VAT): Similar to Sales taxes in other countries, this is a tax on services and goods. 
3. Trade Tax: This tax is calculated on the profits earned from businesses and corporations.

Some statutory deductions, not included in income tax, are deducted from salary:

1. Solidarity surcharge – tax that was initially levied to support the reunification of Germany. From 2021, only those taxpayers whose income exceeds 96,409€ per year are liable to pay it. 
2. Church tax – contribution made by members of recognized churches in Germany. 
3. The employee’s share in health insurance –  mandatory deduction from salary, covering part of the cost of health insurance premiums. 
4. Nursing insurance scheme – again a mandatory deduction from salary that helps fund long-term care in Germany. 
5. Pension insurance fund – one more mandatory deduction from salary, covering the cost of future pensions.
6. Unemployment insurance – is a mandatory deduction from salary, providing financial support to those who become unemployed.

How German Tax system works:

After you arrive in Germany, you will need to register with the citizen’s office to receive a tax identification (ID) number. Your employer will use this number to pay your salary and calculate your tax liability.

Generally, the taxes you owe will be paid to the Federal Tax Office (Finanzamt). At the end of the financial year, the tax office will assess your taxes to make sure that you have paid the accurate amount. If required, the tax office will reimburse you for any overpayment. The taxes you paid will be utilised by the German government to fund various public projects such as schools, hospitals, recreational centres, and more.

To put it simply, here’s how the German tax system usually works:

1. You are employed in Germany.
2. You receive your salary.
3. Taxes are automatically deducted from your monthly salary.
4. The taxes you pay serve to your benefits as a resident of Germany.
5. At the end of the year, adjustments are made to your taxes to correct for potential over or underpayments.

Tax Residency in Germany

Tax residency is a primary factor in deciding whether you need to pay taxes in Germany and how much. 

Tax residency in determined by following criteria:

1. Whether you live in Germany for more than 6 months (183 days) in a calendar year.
2. Whether you have a permanent place of residence in Germany.
3. Whether you have significant interests (i.e., family, business, social) in Germany.

If you have responded yes to all the questions, then you will be considered as a tax resident in Germany and will be required to pay taxes on the income earned both inside and outside of Germany. For someone who doesn’t meet the above criteria, they are recognised as the non-resident, you will only be taxed on income earned solely in Germany. They are subject to withholding tax, which is deducted every month from their income by the employer.

Expats who are tax residents of Germany have to follow the same German tax rates and rules as German citizens, while non-residents have different tax rates and rules. Expats must determine if they are considered as a tax resident in Germany or not. This will have a big impact on how much tax they should pay. Knowing tax residency status can also determine if they qualify for some tax benefits.

Taxable Income in Germany

Once you are aware of your tax residency status, it’s important to know what income is taxable in Germany. For German residents, tax is calculated based on their worldwide income. However, non-resident individuals are taxed on German sources of income only.

Generally, all types of income are liable to be taxed. This includes salary, self-employment income, rental, and investment income. 

The following categories of income are considered taxable in Germany:

1. Agriculture and forestry: Income earned from agricultural land or forestry. 
2. Employment income: Income earned as wages, salaries or other forms of payment earned from your employer. 
3. Independent professions or business: If you work for yourself or as a freelancer in Germany, your income from self-employment will be liable for taxation in Germany.
4. Capital investment: Income you earn from your investments, interests, dividends are subject to tax.
5. Rents and royalties: If you earn income from a property you own in Germany, that income is tax payable under the German tax systems.
6. Other income as defined by tax law

It’s important to note that certain types of income such as pensions, disability benefits, and child support payments may be exempted from taxation in Germany.

German Tax Class

In Germany, there are six different types of tax classes (Steuerklassen) that decide how much income tax in Germany an employee has to pay. These German tax classes, ranging from I to VI, are allocated on the basis of the employee’s personal situation, such as marital status, yearly income, government assistance, etc.

The German tax class determines the income tax rate that is applied to the taxable income and the tax bracket determines the range of income that is subject to that tax rate. This means that, if your tax class or income level changes, you might shift to a different tax bracket with a different tax rate and pay a different amount of income tax.

Income Tax Rates and German Tax Brackets

In Germany, the income tax system works on a progressive tax rate. Meaning that, the more your earning is, the higher your tax rate will be. There are numerous tax brackets in Germany, and each tax bracket has its own tax rate. Depending on your income level, the German tax rates range from 0% to 45% for the year 2023.

These tax brackets are modified every year as per the inflation.

The German tax rates for year 2023 are as follows:

So, for a total income of €60,000:

1. The first €9,408 is tax-free.
2. The next €47,642 (i.e. €57,050 minus €9,408) is taxed at a rate of 14%, resulting in a tax liability of €6,678.68 (i.e. 0.14 x €47,642)
3. The remaining €3,950 (i.e. €60,000 minus €9,408 minus €47,642) is taxed at a rate of 42%, resulting in a tax liability of €1,657 (i.e. 0.42 x €3,950)

Adding up the tax liabilities from each bracket gives a total income tax liability of €8,335.68 (i.e. €6,678.68 + €1,657).

Keep in mind that these rates apply to taxable income i.e. income calculated after relevant deductions and allowances have already been taken into account. Married couples or those who are in a civil partnership, can decide if to file together or separately, which will also affect their tax liability. If you have children, you may be entitled for child-related tax allowances or benefits, which can reduce your taxable income. Additionally, specific deductions and allowances such as contributions towards a private pension plan, healthcare expenses, or charity donations, can be claimed to lower your taxable income.

Double Taxation in Germany for Expats

Germany has signed double taxation agreements with over 90 countries all over the world. Double taxation in Germany is to ensure that individuals are not required to pay tax two times on the similar income. So as an expat in Germany, if you have already paid your taxes in another country, you will be exempted from paying income tax for the same income while you’re in Germany. If you work in multiple countries, you may be liable to pay tax in two countries. 

You can find a full list of countries that fall under the Double Taxation agreement,  on the Federal Tax Office’s website.

If your home/work country doesn’t have a double taxation agreement with Germany, you may be able to claim for a foreign income tax credit instead, which allows you to claim the foreign income tax you’ve paid against your German income tax bill. It’s best to seek the help of a tax consultant to understand this process better.

Deductions and Credits in Germany

As an expat living in Germany, you may think that you’ll be paying a lot of taxes, but there are many tax deductions available based on your circumstances. The German tax system allows a number of deductions that can help you lower your tax liability. 

These include:

1. Child support payments.
2. Relocation expenses
3. Alimony payments.
4. Costs of your child’s care, education, or training.
5. Charitable donations
6. Social security contributions.
7. Work related expenses (if applicable).

To take advantage of tax deductions or to ensure you are not paying more tax than required, be sure to complete your annual tax return on time even if it is not mandatory.

German Tax Calculator

If you’re having trouble understanding how these German tax rules will affect your income, and how much money you’ll receive each month, you can use a German tax calculator to estimate the amount. You can try using this income tax in Germany calculator or this to calculate income tax in Germany for foreigners. 

Filing Tax Returns in Germany

After understanding the basics of the German tax system and Tax Residency in Germany, let’s understand if you are eligible to file a tax return in Germany. If you qualify for certain criterias such as earning over a said amount of income or having multiple sources of income or have earned an income from self-employment, you need to file a tax return. 

In Germany, the tax year runs from January 1st to December 31st of the same year, same as the financial year. The last date for applying tax returns in Germany is generally May 31st of the next year. However, if you’re submitting tax returns electronically, you can do so until July 31st of the following year. And if you miss these deadlines, you may have to suffer from some fines and penalties.

After the tax returns are filed, the German tax authorities will evaluate them and calculate the tax liability. Within a span of a few weeks of the tax assessment, taxpayers who are due a refund will receive a refund, while those who owe taxes will have to pay the amount due within a set time duration.

How to submit a Tax Declaration Report in Germany?

There are three ways to submit the tax declaration report:

1. In-person – By submitting the completely filled tax declaration forms, signing them, and submitting them to the tax office. 
2. Online submission – By submitting online through the ELSTER portal, which is a registration platform managed by the Federal Tax Office.
3. Professional Advisor – If you hire a professional tax advisor, they usually handle the whole tax declaration process for you.

Here are some key takeaways from the article about German tax system:

1. The financial year is the same as the calendar year, i.e., from January to December.
2. The German tax rate is progressive and it varies widely based on factors such as your income, marital status, children, etc. It is advisable to register your family and check your German tax class (Steuerklasse). 
3. After registering, you receive a document known as the “Tax card” or “Lohnsteuerkarte” from the Rathaus about their German tax class and tax office every year. 
4. Tax paid in excess can be claimed back through tax return filing. Be sure to submit your tax return before the deadline and utilise any deductions and credits to lower your tax obligations.