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 turnover, income tax relates to the actual profit that a company makes after deducting all costs and expenses. In Germany, these taxes are levied at various levels, including income tax, corporation tax and trade tax. Income tax primarily affects the income of private individuals, while corporation tax is levied on the profits of companies. Trade tax, on the other hand, affects tradespeople such as sole traders or owners of partnerships. 

‍Significance of income tax in the German tax system

Income tax is a central component of the German tax system and generates a significant proportion of government revenue. These revenues are crucial for financing public services such as education, healthcare and infrastructure.

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

‍Differences between the types of income tax

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 legal form and activities of the company.

- Income tax: Income tax is levied on the taxable income of private individuals and partnerships such as sole proprietorships, GbRs and partnerships. Taxable income is calculated from income and costs within a calendar year. For employees, the gross salary usually makes up the largest part of income. Rental income or non-cash benefits such as a company car can also be included. The amount of tax is progressive. This means that people with higher incomes pay a higher tax rate. There are allowances and various deductions that can reduce the tax burden, such as income-related expenses and special expenses.
- Corporation tax: Corporation 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 uniform tax rate on their profits. Here too, there are certain deductions and regulations that can influence the tax burden.Some corporations, such as non-profit associations, are exempt from this income tax.
- Trade tax: Trade tax is a local tax paid by traders, regardless of their legal form. It is based on trade income and can vary from municipality to municipality. Trade tax is special because it is not based on income and is generally the highest tax burden for companies. However, companies can use an allowance to exempt part of their trade income from tax. The amount of trade tax, which depends on the respective municipality, is regulated by the Trade Tax Act (GewStG).

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 company. In the case of income tax in Germany, for example, there are graduated tax rates that increase as income rises. This means that people with higher incomes pay a higher percentage of their income as tax. 

The exact tax rates can be adjusted from year to year and are set out in income tax tables. In the case of corporate income tax for companies, a uniform tax rate generally applies to profits. It is important to note that there are various allowances, deductions and tax concessions that can affect the actual tax burden. The correct calculation of income tax therefore requires precise knowledge of the current laws and regulations as well as careful accounting and tax planning.

Calculation example for income tax

To calculate income tax for natural persons, income from the types of income defined in Section 2 (1) EStG is added together. This includes, for example, income from self-employment and income from capital assets. The age relief amount, allowable losses from previous years, special expenses and extraordinary expenses are deducted from the total income. Furthermore, allowances are subtracted, which vary in Germany depending on living situation and marital status. For example, the basic annual tax-free allowance for single people is €10,908 in 2023. Income below this limit does not have to be taxed. If the income is higher, only the amount above the allowance is taxed.

If a single person earns 50,000 euros gross per year and there are no special deductions such as special 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 EUR 16,000 and EUR 62,809 in 2023 is 24%. The calculation of income tax is therefore as follows:

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

Calculation example for corporation tax including trade tax

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

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

The trade tax results from the tax assessment amount of EUR 250,000, a uniform percentage rate of 3.5 percent and the trade tax multiplier of 410 percent. The calculation for trade tax in this case is therefore as follows:

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

The GmbH must therefore pay a total of EUR 39,562.50 + EUR 35,875 = EUR 75,437.50 in corporation and trade tax.