Taxable Income
Simply Explained
Simply Explained
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"Taxable income" is a term used in tax law and refers to the amount of income to which the tax rate is applied in order to calculate income tax. It results from the income of a taxpayer after deduction of certain amounts and allowances.
These are the steps that usually lead to the determination of taxable income:
The taxable income is therefore the amount that remains after all the permitted deductions and allowances have been taken into account and to which the respective tax rate is applied to determine the amount of income tax. The tax rate is progressive, which means that the tax rate increases as the taxable income increases. [1]
Taxation of taxable income in Germany (and in many other countries) follows the principle of ability to pay. This principle states that people should be taxed according to their economic performance. This means that those who earn more and therefore have a higher economic capacity should also make a higher contribution in the form of taxes. The calculation of taxable income serves to determine this capacity as fairly and accurately as possible.
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The purpose of taxing taxable income is to distribute the tax burden according to individual financial ability while supporting political, social and economic goals. Here are some reasons why only taxable income is taxed:
| Consideration of personal situation | By deducting certain expenses and personal circumstances (such as special expenses, extraordinary expenses, allowances for children) from gross income, the tax assessment basis is adjusted to the individual's ability to pay. In this way, social and economic differences between taxpayers are taken into account. |
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| Progressive tax system | By determining the taxable income, the progressive tax system can be applied, which imposes a higher tax rate on higher incomes. This promotes social justice by ensuring that the tax burden is distributed according to economic performance. |
| Promoting certain policies | The ability to deduct certain expenses from gross income can be used to promote certain economic or social goals. For example, tax relief for investments in sustainable technologies or for old-age provision can help to steer investments into these areas. |
| Avoidance of double taxation | Specific deductions and allowances can prevent income from being taxed more than once. This applies, for example, to income that has already been taxed in another country or for which capital gains tax has already been paid. |
| Simplicity and administrative burden | Although the income tax calculation system may seem complex, it aims to ensure fair and efficient taxation. The determination on taxable income allows for a standardized calculation method that takes into account a wide range of personal circumstances. |
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The taxable income can be found in the annual income tax return, which is submitted to the tax office. Once all the relevant information has been entered in the tax return, the taxable income is determined by the tax office or by tax calculation programs.
The following diagram shows an overview of the steps to find out the taxable income in Germany.
In order to determine the taxable income, it is therefore necessary to complete the tax return carefully and in full, taking into account all relevant receipts and evidence. Tax software or advice from a tax advisor can help to avoid mistakes and ensure that all tax benefits are used. Here are the steps on how to find out:
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In Germany, income is divided into seven types of income for tax purposes. This classification is relevant for calculating taxable income and thus for determining income tax. The seven types of income are explained here with examples:
This category refers to income from the cultivation of land for the production of plant or animal goods. A concrete example would be a farmer who runs his own farm where he grows grain and keeps cows for milk production. The income includes the sale of milk, grain and possibly subsidies received for agricultural activities.
This income comes from self-employment in trade, crafts, industry or another commercial sector. Let's take the example of a self-employed craftsman who runs a carpentry business. His income is made up of the revenue from furniture produced and services rendered less operating expenses such as material costs, rent for the workshop and salaries for employees.
This category refers to the self-employed provision of services that require higher education or are of an artistic or literary nature. An example of this would be a freelance architect who designs buildings. His income comes from the fees for his planning services, after deduction of professional expenses such as office rent, software licenses and travel expenses.
This refers to income from the transfer of real estate or movable property for use. An example would be an owner who rents out several apartments. The rental income, after deduction of income-related expenses such as maintenance costs, interest on loans to finance the property and depreciation, constitutes his income.
This is income from an employment relationship where the employer pays income tax directly. An example is a teacher at a public school whose salary is paid monthly, less income tax and social security contributions.
This includes income from interest, dividends and other capital gains. For example, a person owns shares in a company that pays an annual dividend. This dividend income, less capital gains tax and any income-related expenses, constitutes income from capital assets.
This category is a catch-all for income that cannot be assigned to the other six types. An example of this is income from private sales transactions, such as the profit from the sale of shares that have been held for more than one year. The difference between the sale price and the purchase price, less the selling costs, constitutes the income from this category.
Each of these types of income is treated according to specific legal provisions and contributes to the determination of total income, which ultimately forms the basis for the calculation of taxable income and thus income tax.
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Which types of income need to be
taken into account? - An overview
| Income from agriculture and forestry | This includes income from the cultivation of land used for the cultivation of plants or animal husbandry, as well as from the use of natural resources. This also includes income from forestry and viticulture. |
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| Income from business operations | This includes income from any self-employed, sustainable activity with the intention of making a profit that constitutes participation in general economic transactions. This also includes commercial sole proprietorships and shares in partnerships. |
| Income from self-employment | This category includes income from freelance work, such as that earned by doctors, lawyers, engineers, architects, journalists or artists. A distinction is made here between freelance work and other self-employed work. |
| Income from employment | This includes salaries, wages, bonuses, royalties and other emoluments and benefits paid for dependent employment. Pensions and annuities from previous employment also fall into this category. |
| Income from capital assets | This includes interest from savings investments, dividends from shareholdings, income from investment funds and similar investment income. Since 2009, this income has been subject to withholding tax in Germany. |
| Income from renting and leasing | This type of income refers to income from renting and leasing real estate, land or other tangible assets. |
| Other income | Other income includes, for example, pensions, income from maintenance payments, speculative gains (from private sales transactions that fall outside the speculation period) and certain benefits such as severance payments for the loss of employment. |
Each of these types of income is subject to specific tax regulations that must be taken into account when determining taxable income. Depending on the type of income, different allowances, lump sums and income-related expenses may be relevant. The total income from these seven types of income forms the basis for calculating taxable income.
The calculation of taxable income in Germany is done in several steps and takes into account different types of income, expenses, deductions and allowances. Here is a simplified illustration of the calculation process:
1. Determination of income from various sources
First, the income from all seven types of income is compiled: agriculture and forestry, business, self-employment, employment (e.g. salary), capital assets, renting and leasing and other income (e.g. pensions, maintenance payments). However, it is rare for income to come from all seven sources. Usually only a few sources occur at the same time.
2. Deduction of income-related expenses
Income-related expenses can be deducted from income. Income-related expenses are expenses that serve to acquire, secure and maintain income. These include, for example, travel costs to work, training costs or expenses for work equipment.
3. Total amount of income
After deducting the income-related expenses from the income from the various sources, the total amount of income is obtained.
4. Deduction of special expenses and extraordinary expenses
Special expenses and extraordinary expenses can be deducted from the total amount of income. Special expenses include contributions to health and long-term care insurance, pension contributions, donations and church tax. Extraordinary expenses are major expenses that a taxpayer inevitably incurs and that exceed the normal standard of living, such as high medical costs.
5. Deduction of allowances
In addition, allowances such as the basic allowance, child allowances or the age relief amount can be deducted to reduce the tax burden.
6. Taxable income
After deducting all allowable amounts from the total amount of income, the taxable income is obtained. The tax rate is applied to this income to calculate the income tax.
Let's assume a person has a gross income from employment of 50,000 euros, income-related expenses of 1,000 euros, special expenses of 2,000 euros and is entitled to the basic tax-free allowance (in 2023: 10,347 euros for single people in Germany).
The corresponding tax rate is applied to the taxable income of EUR 36,653 to calculate the income tax liability.
This calculation is highly simplified and may vary depending on your individual situation. Tax regulations can be complex and there are many specific provisions that need to be taken into account. Therefore, it can be helpful to seek professional tax advice or use specialized tax software.
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Tax-free amounts are amounts that are deducted from taxable income before income tax is calculated. They are used to take into account the tax-free basic needs of a taxpayer or certain personal circumstances. There are different types of tax-free amounts that can be applied to taxable income depending on the taxpayer's individual situation. The amount and applicability of these tax-free amounts can change over the years, depending on legal adjustments.
These are some of the most important tax-free amounts in Germany:
1. Basic tax-free allowance
2. Child allowance
3. Single parent relief amount
4. Employee lump sum
5. Saver's lump sum
6. Relief amount for single parents
These tax free amounts are automatically taken into account in the income tax return, provided that the requirements are met and the corresponding information is provided. They reduce the taxable income and thus the tax burden. It is important to check the current tax free amounts and requirements regularly, as legal regulations can change.
These distinctions are important to understand how taxable income is determined step by step in Germany, starting with raw income and ending with taxable income, which is ultimately used to calculate income tax. Here, therefore, is a table that clarifies the differences between receipts, income, earnings and taxable income, particularly in terms of their role in calculating taxable income:
| Term | Definition | Reference to taxable income |
|---|---|---|
| Revenue | Gross income from one or more of the seven types of income, before deduction of income-related expenses or operating expenses. | First step in calculating taxable income. |
| Income | The result after deducting income-related expenses or operating expenses from the income. For some types of income, it may also be after deduction of tax-free amounts or lump sums. | Intermediate step; income forms the basis for calculating income. |
| Earnings | Total income from all sources after deduction of special expenses, extraordinary expenses, other deductions and tax-free amounts. | Penultimate step; direct preliminary stage of taxable income. |
| Taxable income | The income after further deductions (e.g. age relief amount, relief amount for single parents), which serves as the basis for calculating income tax. | Final basis for calculating income tax. |
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Income tax in Germany is calculated using a progressive tax scale, which means that the tax rate increases as income rises. There are different tax brackets and rates that apply depending on the amount of taxable income and personal situation (e.g. single, married). As of 2023, here are the main features of the German income tax scale:
These figures are general guidelines. The actual tax burden may vary depending on individual circumstances (e.g. special expenses, extraordinary expenses, tax free amounts, taxable income). There are also different tax brackets for different life situations, which can influence the amount of tax prepayments. For an exact calculation of the tax burden on taxable income or for specific questions, it is advisable to consult a tax advisor or use an up-to-date tax calculation program.
Taxable income below the basic tax-free allowance is the amount of income below the tax-free threshold up to which no income tax is levied. In Germany, the basic tax-free allowance is the amount of income up to which there is no tax liability in order to make the minimum subsistence level tax-free. If a person's taxable income is below this amount, they do not have to pay income tax. The basic tax-free allowance therefore serves to protect the taxable minimum subsistence level.
Parental allowance is not considered taxable income in Germany as it is tax-free. However, it is subject to the progression proviso, which means that it is taken into account when determining the tax rate applied to other taxable income. This can lead to an increase in the tax rate on other income and thus indirectly increase the tax burden, even though the parental allowance itself is not taxed.
You will find your relevant taxable income in the income tax assessment notice issued by the tax office after your tax return has been submitted and checked. The tax assessment notice contains detailed information about the calculation of your tax liability, including the taxable income on which the tax was calculated.
To reduce your taxable income, you can claim income-related expenses, special expenses, extraordinary expenses and tax free amounts such as the employee lump sum, pension expenses and donations. You can also deduct depreciation for items used for professional purposes and costs for professional training. Claiming child allowances and using tax-privileged pension products are further ways to reduce your tax burden.
