The financial impact of tax classes
This article shed light on the often misunderstood concept of the German tax classes. It is wise to make yourselves knowledgible early on in your process of moving to Germany since the choice of tax classes is one of the first you will make when in Germany. The tax classes are an instrument to lower the financial burden of monthly tax payments for married couples and single parents.
Content of this article
The Taxation of Couples
Marriage is regarded highly in Germany, so much so, the taxman offers lucrative incentives to married couples. The impressive word “Ehegattenzusammenveranlagung” encourages marriage; financially. This tongue twister means that two become one, via "couple tax." The couple is taxed as one subject.
In short, the income of both spouses is added up, then divided by two. The applicable tax rate is then used leading to a significantly lower tax amount.
The “couple taxation” reduces the actual tax burden, the then applied tax class spread the tax monthly, resulting in a positive impact on cash flow. For married couples the most common combination of tax classes are III, and V. One spouse will have III and the other V.
The tax classes also aim to benefit single parents, for example, tax class II (scroll down for more information). It lowers the financial burden for divorced parents, especially those that financially take care of the child or children.
Couple Taxation – requirements for entitlement
To qualify for couple tax, generally speaking, you must be married – or have an official and legally binding certificate stating that you are “registered partners”. Whether or not such statement issued by a third country will be accepted by the German finance authorities is depending on the issuing country. And, you need to live together, at least for the majority of the year.
Another essential tax requirement is that both partners must live in Germany.
There are exceptions to both rules:
- If you have lived together in Germany, but one partner has to move away for a longer time (i.e., a job offer), you don’t need to change the taxation back to single.
- If the person applying for couple taxation is EU citizen, 90% of the couple’s income is generated in Germany, OR the spouse’s income does not exceed the basic deductible, AND the spouse, whatever nationality, lives in an EU country.
Applying for Couple Taxation
The choice between “single” and “couple taxation” is your own and must be actively chosen by ticking the box on the annual tax form. If a couple tax is chosen, then both parties must sign the form to validate the option. The decision to change back to single or couple tax can be done only once a year and in writing.
The method chosen will always apply to the entire taxable income of one calendar year.
The first time you can opt for either method is the year of your marriage. You can marry on 31st December and still go for “Couple Taxation” for that year. Income is not deferred.
The math: Calculating the tax amount for married couples under “couple taxation”
The difference between single taxation and couple taxation by example:
- Husband John earns 75.000 EUR taxable income, his wife Mary earns 0. If not married, John’s tax would be 42% x 75.000 EUR - 8.780,90 EUR = 22.719 EUR.
- If married, AND "couple taxation" is opted for, first both incomes are added up: 75.000 EUR + 0 EUR = 75.000 EUR. Then divided by two: 37.500 EUR. This income would be subject progression II. The rate is (37.750 – 14.254)/10.000 = 2,3246. The tax (216,16 * 2,3246 + 2.397) * 2,3246 + 965,58 = 7.705 EUR is then doubled: 15.410 EUR
The biggest impact is with the example above, where MAry earns nothing. The more Mary earns the lesser the impact will be.
Tax classes – impact on the tax amount
FACT! The tax class has NOTHING to do with the tax amount!
The tax class impacts ONLY the monthly distribution of tax payments.
In order to calculate taxes, employers make assumptions based on the tax class in which you are in. Tax classes mean that the employer calculates the annual tax payment and then divides it by 12. To be most precise, it is not the employer doing this; it is the program utilized for such purposes. Since the Finance Authorities are not stupid, they assume a higher income than the mere salary calculation suggests. Be it by a second income or higher tax deductibles. As a result higher tax payments are likely.
The concept is not uncommon – the finance authorities want to make sure you can pay the tax – if they didn’t collect it on a monthly basis they would run the risk that by year end you have spent all your money on lipstick or football tickets.
Overview on the tax classes existing
- Tax class I: the yearly tax amount is divided by 12. No partner deductibles involved.
- Tax class II: for single parents. A higher tax deductible is applicable for childcare.
- Tax class III: for married or registered couples where the partner earns up to 60% of the family income.
- Tax class IV: for married or registered couples where both partners earn roughly the same money, i.e. one earns 59% and the other 41%, or it is 50:50. Resulting in the same monhtly tax payments as under tax class I
- Tax class V: for married or registered couples where the partner earns less than 40% of the family income.
- Tax class VI: where the tax id is amiss, or when two jobs are held – then for the second, less earning job
Tax classes – your options
If John and Mary are not married, they can only opt for tax class 1. In seldom cases, you could be assigned a tax class VI, which assumes that you have a second job and your total income is above progression III. Your employer is forced to choose tax class VI if you don’t provide your tax id. This tax class assumes that the annual tax calculated under tax class I would not suffice to pay the actual tax debts. Consequently, the monthly tax is set even higher.
Tax class II and VI are also not chosen but assigned by the tax authority. Some websites recommend thinking twice before taking on a second job as you will pay a lot of taxes. This is not a well-informed recommendation. The tax you eventually pay has NOTHING to do with the tax class. It ONLY depends on your taxable income. It is true; however, that tax class VI will assume the highest tax rate, and therefore the monthly deductions will be very high. By year-end, and via your – then obligatory – annual tax declaration you will get back any overpayments made. So, psychologically, income with tax class VI seems disadvantageous. Always remember, this is only psychologically. Not financially.
If John and Mary are married and choose “Couple Taxation,” they can choose 2 alternative combinations of tax classes: III & V or IV & IV. One income is assigned to tax class III, and the other income to tax class V. Or both incomes are assigned tax class IV.
They always go hand in hand. It is impossible to choose I & III or III & III. This is also the reason why married couples, where the partner does not live in the EU, cannot opt for “Couple Taxation.”
The cashflow effect of tax class III and V
Let’s assume John and Mary are married and they opt for “Couple Taxation." The calculation is not by way of formula but by way of official tax tables published by the finance authorities. These tables don’t start with the taxable income but with the gross salary. The taxable income is lower than the gross salary as social security contributions reduce the taxable income, and so do the basic tax deductible as well as child allowances and other costs. In order to make it comparable, we will compare 75.000 EUR gross salary with tax class I to tax class III. The calculation is further dependent on the health insurance chosen and where in Germany one lives, but we will ignore these factors for now and simply keep them unchanged.
Assumption 1: John earns 100% of the income.
The tax amount - the actual due payments for a fiscal year
- The actual tax amount for a taxable income of 75.000 EUR – 9.168 EUR basic tax deductible – roughly 13.000 EUR social security contribution = ~52.800 EUR is 15.361 EUR. This is what unmarried John and Mary would owe to the fiscal authorities.
- In case John and Mary choose “Couple Taxation” the taxable income is 75.000 EUR – 9.168 EUR x 2 – roughly 13.000 EUR social security contribution = ~ 40.000 EUR and the resulting tax amount, using the so-called splitting table for couple taxation, is roughly 5.093 EUR.
These numbers show again that "couple taxation" makes huge sense financially where one partner earns significantly more than the other.
The effect of Tax class III versus I:
- Tax Class III: The monthly tax payment for John would be 972,33 EUR resulting in an annual payment of 11.667 EUR.
- Tax Class I: The monthly tax payment for John would be 1.493,66 EUR resulting in an annual payment of 17.923 EUR.
Both results are not a 100% match to the tax amount, because the tax classes make use of further assumptions. But one can still see that the paid amount under tax class I is significantly higher than under tax class III and that the amount under tax class III is closer to the actual due tax amount of 5.093 EUR.
What you can also see, is, that even with tax class III John and Mary will have overpaid by year end. And only a tax declaration will get them their overpayment back. Hence, filing an annual tax declaration makes huge sense financially.
Assumption 2: Mary earns 40% of the family income
Now, let’s assume Mary earns something, let’s say she earns 18.000 EUR gross salary and John 57.000 EUR.
John and Mary choose couple taxation and the combination III & V:
- Tax Class III: John would have a monthly gross of 4.750 EUR and tax payment of 557,66 EUR (yearly 6.691,92 EUR) – so it’s roughly 13% of his gross salary
- Tax Class V: Mary would have a monthly gross of 1.500 EUR and tax payment of 239 EUR (yearly 2.868 EUR) – roughly 15% of her gross salary.
Joint annual tax paid would be 9.559,92 EUR
John and Mary are both choosing either tax class IV
- With tax class IV John would pay 923,93 EUR taxes per month (11.077,92 EUR per year), i.e. 19%.
- And Mary, also tax class IV, would pay 71,33 EUR taxes per month (855,96 EUR per year), i.e. 5%
Joint annual tax paid would be 11.933,88 EUR
Remember the joint annual tax amount when opting for couple taxation is 5.093 EUR since the family income did not change.
The financial effect is similar as above. If John and Mary opt for tax classes III and V they will have overpaid, but to a lesser extent than when choosing I and I, or IV and IV respectively.
There is a psychological disadvantage for Mary when choosing tax class V for her. She will see 15% taxes on her gross salary on a monthly base, and it is difficult to ignore this and consider parts of John’s income as her own. Which is actually true! Mary pays a higher tax and John benefits from it because he pays less tax.
Tax class IV & IV – when to choose
The above ratio becomes less beneficial (i.e., the overpayments become less and less) the more the spouse earns. One can roughly say that once the spouse makes more than 40% of the joint income, one should choose tax classes IV & IV.
Tax class IV is the same as tax class I.
Let’s assume John and Mary earn both 37.500 EUR. Under tax class IV their tax paid on a monthly basis is 447,75 EUR, both, and annually 5.373 EUR. I.e., they pay 10.746 EUR per year and tax return would be roughly 5.600 EUR.
Taking on side job for few money
Whether or not Mary takes on a side job (which will keep her in tax class V) is not a question of the tax class, but, it is a question of social security contributions. There are limits set by the health insurances (mostly they follow the mini job salary). When earning more than 450 EUR a month, there is a financial disadvantage of roughly 150 EUR per month as she will fall out of the family insurance. When Mary is offered a job for 600 EUR it is not unlikely; the health insurance will take 150 EUR from it so that the additional hours are going directly into the premiums. However, some insurers would also offer a staggered premium. Always contact your health insurer to understand their rules when a job offer comes your way for a part-time job.
As a single expatriate coming to Germany, you have no choice, you will be tax class I, and you cannot make use of the “couple taxation.”
Married expatriates, with both partners coming to Germany, can opt for “couple taxation” and since they will predominantly see the scenario with “John” earning 100% the most beneficial tax class to optimize monthly cash flow is the combination III & V. Opting for “single taxation” makes no sense with regards to cash flow optimization.
Where you are EU citizen and married, but your spouse does not join you in Germany and stays in your non-EU home country, you will be subject tax class I, and you cannot opt for “couple taxation.” If your spouse resides in an EU country, there are chances you can. Since this is a more complicated process, you should have this handled by your tax consultant.
Your tax consultant will advise on the most beneficial tax classes to choose under an adjusted scenario (i.e., should “Mary” find a job which seems to earn more than 40% of the family income). If a new job generates less than 40% of the family income, you don’t need to adjust the tax classes. If she earns more than 60% of the family income, you should change “John’s” tax class to V and give Mary the III. An easy adjustment, made by simply telling the finance authorities via an E-Form.
Whatever scenario you choose, the tax classes make sure you slightly overpay your actual tax amount due. Filing an anual tax declaration is with 90% surety financially wise. The charges of a tax consultant is usually lower than the returns you will get.