Paying income Tax In Germany is not fun. You hate it, we hate it, everybody hates it. But paying taxes is part of being an adult. Problem is, that most Employees In Germany probably pay a lot more in income tax than they should be paying. To help you in paying the least amount of taxes, let us Explain how income tax in Germany works in this article.
The income tax you have to pays as an employee in Germany is mainly determined by your Payslip (just like the amount of Social Security Contributions you have to make). In fact, your Income Taxes that are deducted from your payslip are defined by 2 factors: Your income & your income tax class. What is a tax class? 🤔
Tax Classes in Germany
Every employee in Germany falls into one of the 6 German Income Tax Classes so Finanzamt knows how much of the gross salary can be taxed. The difference between your Gross Salary And Net Salary can be easily a couple of hundred Euros with a different (better) income tax class. See the list below if you can change to a better income tax class.
The best income tax class is class 3 as you have to pay the least Taxes On Your Income. But in Germany, you cannot choose your income tax class at will. Your income tax class is mainly chosen for you based on your family status. Single people basically have no choice to change their income tax class, only married couples have some freedom to choose.
Married person with high income (other person has to be 5)
Married couple with equal/similar income
Married person with no or low income (other person has to be 3)
2nd job or part-time
As you can see, only married couples have several options when choosing their income Tax Class. As long as both people live within the European Union you can utilize income tax class 3 + 5 if one spouse is working with a High Income and one spouse is working with a low income or no income.
Income tax class 3 has to pay very little in taxes compared to income tax class 5. Working in income tax class 5 is definitely not fun if you have a look at your German Payslip. But for the married couple as a union, it will be best and save them a lot in taxes. But please do not marry just for Tax Purposes. A divorce is more expensive than any tax benefits. 😉
But if you want to marry anyway, you better marry in December than in January from a Financial Perspective. If you marry in December, you will get your tax benefits for the whole year already behind you (from January to November). If you marry in January, you missed out on your Tax Benefits. The difference between December 31st vs. January 1st can mean Financial Success in Germany.
Are you missing out on important deadlines for financial success?
Your income tax class is the first factor that determines how much Taxes You Have To Pay in Germany. Working in income tax class 5 or 6 is definitely not fun, as you have to pay a tremendous amount in taxes each month from Your Payslip. In order to get at least some of the taxes back you paid, you can file a tax declaration in Germany. Why?
Because your German income Tax class is only a preliminary assessment of how much your income will be and how much taxes you will have to pay based on That Income. That does not mean the preliminary assessment will be right. If it is not right, you are either Paying Too Much In Taxes or too little in taxes. As you can probably imagine, both are not good.
If you paid too little in taxes, Finanzamt will make you pay (with penalty interest) as soon as they find out. If you paid too much in taxes, you are gifting Germany that is actually yours. So definitely File A Tax Declaration and pay just the right amount of taxes. 9 out of 10 people filing a tax declaration in Germany get on average 1.000€ Tax Money back.
Marginal vs. Average Income Tax
The second determining factor (besides your income tax class) is Your Tax Rate you have to pay on Your Income. As nothing in Germany is particularly Easy, we have to differentiate 2 different tax rates you will have: Your marginal income tax rate and your average income tax rate.
You can see in the graph above that income up to 9.408€ is Completely Tax-free in Germany (in 2020). After that, the amount of taxes you have to pay is a fixed percentage of Your Income that starts with 14%. So if you would earn 9.409€ in 2020, you would have to pay 14 cents in income tax that year (14% of 1€ above 9.408€).
This income tax rate that is a percentage of your income is the Marginal Income Tax Rate. The marginal income tax rate (blue line in the graph) determines how every Euro is taxed individually. So 14% after 9.408€ rising very fast in the 20% range and then to 42% until 270.501€. While this is the marginal income tax rate you are paying, that is not the actual income tax You Have To Pay.
You have to pay your average income tax rate to Finanzamt. The average income tax rate (red line in the graph) tells you how much your income is really Taxed as a percentage of Your Total Income. As you can see: The more you earn, the higher your marginal income tax rate and the higher your average income tax rate.
If you are a member of the church, you will pay Church Tax straight from your Payslip. Church tax is always a percentage on top of your Income Tax you have to pay (8% in Baden-Württemberg & Bavaria, 9% in all other German states). So for every Euro, you pay in German income tax, you have to pay an additional 8€ or 9€ in church tax.
The third and last Tax that is automatically deducted from your Payslip is Solidarity Tax. Most employees do not pay solidarity tax since 2021 anymore as the German government decided to abolish this tax for most people when it comes to income from work. High-earning Employees, businesses, and Investors still have to pay 5,5% solidarity tax on their income.