German Tax System Explained

The German tax system can seem overwhelming at first. With the different tax classes, the tax ID and the different purposes for taxes a lot of Germans get confused as well. In this article we’ll give you a basic understanding of the German tax system to help you navigate through all your administrative tasks! By the way, tax is called Steuer in German.

A quick overview of the German tax system

There are different types of taxes in Germany. All the taxes that the state, the federal states and the municipalities collect are used to create infrastructure for the common good - be it schools, roads or social security. In addition to income tax (Einkommensteuer) and turnover tax (Umsatzsteuer), there is, for example, dog tax, motor vehicle tax, church tax or trade tax. The most important types of tax and explanations can be found on the website of the Federal Ministry of Finance.

A distinction can be made between direct and indirect taxes. Wage tax (Lohnsteuer) is a direct tax because it is deducted directly from your salary and passed on to the tax office. Turnover tax (Umsatzsteuer), on the other hand, is an indirect tax. You pay it indirectly when you buy food for example. The turnover tax (Umsatzsteuer) is included in the price you pay for the products, which the trader then pays to the state. Colloquially, the Umsatzsteuer is also called Mehrwertsteuer. Therefore, you will often find the abbreviation MwSt. on your receipts when you go shopping.

All you need to know about Lohn- und Einkommensteuer

The wage tax (Lohnsteuer) is a special form of the income tax (Einkommensteuer). While wage tax (Lohnsteuer) is automatically paid to the tax office from your salary, income tax (Einkommensteuer) describes the tax on all income of any kind. This can be income from self-employment, renting out your holiday home, etc., in addition to your salary.

As soon as you are employed by a company, your employer pays a certain amount of your salary to the tax office. This is the wage tax (Lohnsteuer). What remains for you, after further contributions to the health insurance fund, social security and pension insurance, is the net wage (Nettolohn) that is paid to you each month.

There are six different wage tax classes that determine how much tax is deducted from your salary. The class to which you belong depends on certain factors.

• Tax class I: single, separated or divorced employees, usually without children
• Tax class II: single employees who are entitled to the relief amount for single parents (Entlastungsbetrag für Alleinerziehende) 
• Tax class III: married employees, where the partner falls into tax class V (even if the partner does not work, one can fall into tax class III)
• Tax class IV: married employees who both fall into tax class IV
• Tax class V: counterpart to tax class III, applies only to married couples
• Tax class VI: only applies if you have a second job

Spouses can choose whether they both fall into tax class IV or one of them into tax class III and the other into tax class V. Married couples are considered an economic unit under tax law and are given preferential tax treatment compared to couples who are not married. When deducting wage tax (Lohnsteuer), there are also certain allowances (Freibeträge) that are included. These include the child allowance (Kinderfreibetrag), the care allowance (Betreuungsfreibetrag) and the relief amount for single parents (Entlastungsbetrag für Alleinerziehende).

What is an income tax return?

An income tax return (Steuererklärung) is a declaration of income and expenditure to the tax office (Finanzamt), which uses the documents you submit to calculate the amount of income tax (Einkommensteuer) you will pay. The wage tax (Lohnsteuer) is an estimate. Certain expenses can reduce the tax burden. After your tax return has been checked, you will receive a tax assessment from the tax office, which will determine whether you have to additionally pay tax or whether you will get a partial refund of the tax you have already paid.

If you are employed, you do not have to file a tax return (unless otherwise requested by the tax office), as wage tax (Lohnsteuer) is automatically deducted. If you are employed, you can file a tax return voluntarily. It can be worthwhile, however, as in many cases there are tax refunds. However, if you are self-employed or work as a freelancer, farmer or forester, you must always file a tax return so that your income can be taxed.

Depending on where you live, a certain tax office (Finanzamt) is responsible for you. Check on steuer.de which tax office is responsible for you by entering your postcode!

It is possible to file your tax return online. With the help of the ELSTER tool (Electronic Tax Return), you can fill out forms online, get explanations of the information you need to provide, and avoid a lot of paper chaos. In any case, to file a tax return, you need your tax identification number or tax ID (steuerliche Identifikationsnummer), the wage tax statement (Lohnsteuerbescheid) from your employer and, if applicable, other documents such as receipts and vouchers.

Of course, you can also hire a tax advisor or the wage tax help association (Lohnsteuerhilfeverein) to help you fill out the forms and collect all the documents. They will usually also take care of communicating with the relevant tax office.

Tax Identification Number (steuerliche Identifikationsnummer)

Your Tax Identification Number (steuerliche Identifikationsnummer) is required when you are applying for a new job in Germany or filing your income tax returns. If you are registered in Germany and are liable to pay taxes, you have to have a Tax ID number and you receive it automatically after your relocation and registration in Germany. 

It is a 11-digit number and never changes. It can be used for every tax purpose. The Bundeszentralamt für Steuern or the Federal Central Tax Office issues the tax number to every resident in Germany. The Federal Central Tax Office in Germany stores various other information of an individual while issuing the tax ID; your first and last names, your current address, your academic qualification, your religious name, your date and place of birth, your gender, your tax office (Finanzamt) and your date of death. The tax ID is valid even after you die.

There are several reasons why the German government introduced the concept of tax IDs in 2007. It was a part of the government's strategy towards digitalisation. Their main intention was to replace the old tax numbers of the tax office. With one tax number, it becomes very easy and simple to communicate with the official authorities. It also simplifies the communication process between the authorities like pension offices or tax offices themselves. Tax IDs also help in tracking if you have exceeded your savings allowance or if child benefits (Kindergeld) have been paid out more than once by mistake. Hence, tax evasion becomes more difficult with tax IDs. 

Places where Tax IDs are a must

• Employer - your Tax ID is required by your employer to pay your salary. Mini jobbers do not have to pay taxes (450 euros or less) and hence, it is not required 
• Tax office correspondences
• Opening bank accounts (introduced since 2018)
• Application for child benefits (Kindergeld) at the family benefits office (Familienkasse) introduced since the year 2016
• BAföG application (student grants and loans provided by the German government) - the student unions in Germany require the tax IDs for transfer of relevant information to the tax authorities. Information regarding long-term care insurance, health insurance, etc. are stored for future reference 
• Pension insurance institutions for transmitting pension payments 
• Exemption orders introduced in 2011
• Deduction of alimony (Unterhaltsleistungen) 

Your income tax assessment that you receive is also sent to your employer with the use of your tax ID. Tax ID is a very essential number if you are residing in Germany long-term. Keep it safe at all times to get your necessary work done and you will be all set. 

Hopefully, you now have a better understanding of the German tax system and your role in it. If there are any questions, please comment below, connect with others in the New2 FORUM or write to us at [email protected]!

Last Update: 10 Feb 2022

Written by: Sanchari Banerjee and Tanja Holbe 

Cover Photo: stevepb - pixabay

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