German Tax System Basics

The German tax system is a detailed structure that pays for public services, supports social balance, and guides economic activity. It combines direct taxes (like income tax) and indirect taxes (like VAT). It has been strongly shaped by German reunification in 1990 and by Germany’s role in the European Union. A key idea is fairness: everyone pays according to their ability, and people with higher incomes pay a higher share. This progressive system helps finance schools, healthcare, roads, and social benefits.

Knowing how this system works is important for residents and non-residents, because it affects salaries, investments, and business decisions. The German system is wide-ranging, from the main taxes such as income tax and VAT to more specific ones like church tax and motor vehicle tax. This guide gives an overview of the main parts: who pays which taxes, who runs the system, and the main rules behind German taxation.

German tax system: Key features and structure

The German tax system is complex, but it is based on clear rules in the Constitution (the Basic Law, or Grundgesetz). This document carefully divides taxing rights between the federal government, the states (Länder), and the municipalities. Some taxes are charged directly on income and profit, while others (like VAT) are added to the price of goods and services. Using both types helps the state raise money and also influence social and economic policy.

Reunification and EU membership have both strongly shaped today’s tax structure, bringing it in line with modern economic conditions and international rules. The result is a system that aims for fairness and efficiency and supports Germany’s social market economy.

Which institutions administer taxes in Germany?

Different levels of government help run the tax system. At the federal level, the Federal Central Tax Office (Bundeszentralamt für Steuern, BZSt) is key. Created in 2006 as a separate body from the Federal Ministry of Finance, it is responsible for tasks such as issuing tax identification numbers and managing certain federal taxes (for example, insurance tax and fire protection tax).

However, most everyday tax work happens in the state tax administrations, especially in the local tax offices (Finanzämter). There are about 650 local offices in Germany. They handle tax returns, assess taxes for individuals and companies, and collect “shared taxes” on behalf of both the federal and state governments. For most people, the local tax office is the main contact point. Tax disputes go first to the Fiscal Courts of the states, and appeals from there can be taken to the Federal Fiscal Court (Bundesfinanzhof) in Munich.

How are taxing powers distributed between federal and local governments?

Who may create and collect which taxes is set out in Articles 105-107 of the Basic Law. This avoids overlaps and sets clear duties for each level of government.

The federal government makes the rules for customs duties and most excise duties (such as taxes on mineral oil, tobacco, alcohol, coffee, and electricity). It also receives the money from these taxes, together with insurance tax and the solidarity surcharge. The states (Länder) collect and receive taxes such as inheritance tax, real estate transfer tax, beer tax, gambling taxes, and fire protection tax. Municipalities can set local taxes like property tax (Grundsteuer), trade tax (Gewerbesteuer), and smaller local levies such as dog tax.

The largest part of revenue comes from “shared taxes,” mainly income tax and VAT. These are split between the federal and state levels; municipalities get a portion through payments from the states. A system called fiscal equalization (Länderfinanzausgleich) under Article 107 then shifts money from richer states to poorer ones to even out differences in financial strength.

What is the fiscal code and why is it important?

The fiscal code (Abgabenordnung) is the basic law for all taxes in Germany. It sets the general rules and procedures that apply to every type of tax, regardless of the specific tax law. It is the central legal framework for how taxes are defined, collected, and enforced.

The fiscal code is divided into nine parts that follow the normal order of a tax procedure. It starts with basic definitions and rules that apply to all taxes. It explains what counts as a tax, how tax debts arise, and what principles must be followed. Important ideas in the code include:

• Ability-to-pay principle: Tax should be based on a person’s financial capacity.
• Equal treatment: People in similar situations should be taxed in the same way.

Without the fiscal code, tax law would be fragmented and unclear. The code gives taxpayers and authorities a stable and predictable set of rules to follow.

What are tax identification numbers and how are they used?

Tax identification numbers are key tools for modern tax administration. Since 2009, every person who lives in Germany or is otherwise required to pay tax there receives an 11-digit tax ID (Steueridentifikationsnummer) from the BZSt.

This number is unique and permanent. It is issued once, usually soon after birth for German residents, and stays valid for life. You must state your tax ID when you file a tax return, contact the tax office, or provide data to authorities. Employers, the Employment Office, and health insurers may also ask for it. Businesses receive a separate business ID (Wirtschaftssteuer-Identifikationsnummer).

In practice, most people have two main numbers:

• Tax ID (Steueridentifikationsnummer): Permanent, issued by the BZSt.
• Tax number (Steuernummer): Issued by the local tax office for specific taxes; it can change if you move to another district.

If you are registered in Germany, your tax ID is usually sent by post. You can also find it on your annual wage tax statement (Lohnsteuerbescheinigung) or your tax assessment notice (Steuerbescheid).

Who pays taxes in Germany?

Taxation in Germany depends not just on earning money, but also on where you live and where your income comes from. The idea is that anyone who earns income in Germany or benefits from its infrastructure should contribute to its funding. This applies to both individuals and companies.

If you earn money in Germany or do business there, you are usually part of the tax system. This broad approach helps finance the country’s wide range of public services and social benefits.

Who is liable for taxes as a resident or non-resident?

Tax liability mainly depends on residence. People who live in Germany are subject to unlimited income tax liability. They are taxed on their worldwide income, regardless of where it is earned. You are treated as a resident if you have a home in Germany that you keep for more than a short period or if you usually stay in Germany for more than six months. This six-month threshold can extend over two calendar years. Citizenship usually does not matter for residency, though some tax treaties may consider it in certain situations.

People who are not residents have limited tax liability. They pay income tax only on income from German sources. For example, employment or investment income from Germany is often taxed by withholding. Non-residents can choose to be treated like residents if at least 90% of their worldwide income is taxable in Germany, or if their foreign, non-taxable income stays below a set amount (for 2024, €11,604). This option allows them to claim the same deductions and allowances as residents.

Corporations that are managed or have their legal seat in Germany are fully liable for corporation tax on both domestic and foreign profits. Corporations without such a link are taxed only on income from German sources.

What types of income are subject to tax?

German income tax law lists several types of taxable income to cover most ways of earning money. These include:

• Income from agriculture and forestry
• Income from trade or business
• Income from self-employed work (e.g. doctors, lawyers, tax consultants)
• Income from employment (wages, salaries, bonuses, pensions)
• Income from capital (interest, dividends)
• Income from renting and leasing (rents, royalties)
• “Other income” as defined by law

Some payments are tax-free, such as parental allowance (Elterngeld), unemployment benefits, BAföG (student support), and most scholarships. Income from a mini-job and income below the basic tax-free allowance (Grundfreibetrag) is also not taxed. The basic allowance is €12,096 in 2025 and is meant to protect a minimum subsistence level from income tax.

German income tax: Principles and rates

Income tax (Einkommensteuer) is the most important single tax in Germany and brings in the largest share of public revenue. It follows a progressive pattern: as income increases, the tax rate rises.

The combination of progressive rates, tax classes, and many deductions makes income tax a detailed system for individuals. For employees, it usually appears as wage tax (Lohnsteuer), which is withheld by the employer. Knowing the basic rules helps you manage your finances more effectively.

How does income tax work for individuals?

Individual income tax in Germany is progressive, meaning higher incomes are taxed at higher rates. Anyone who lives and works in Germany is generally subject to this tax.

To calculate taxable income, you start with your total gross income for the year. You then subtract income-related expenses for each type of income (for example, work-related costs from employment income). Losses from most income categories (except capital income) can usually be offset against gains in other categories, although there are limits for “other income.”

After subtracting income-related expenses, you can deduct certain special expenses and allowances, either as lump sums or up to actual amounts allowed by law. What remains is your taxable income. Employees usually pay income tax through wage tax: their employer deducts it from the salary and sends it to the tax office. The employer uses the employee’s tax class and any known allowances. The tax year runs from January 1 to December 31.

What are the current income tax rates and tax brackets?

Germany uses a progressive tax scale. For 2025, the income tax for single taxpayers looks like this:

• 0%: €0 to €12,096 (basic allowance, no tax paid)
• 14%-42%: €12,096 to €68,429 (rate rises gradually from 14% to 42%)
• 42%: €68,430 to €277,825
• 45%: €277,826 and above (top rate)

For married couples filing jointly, all thresholds are roughly doubled. For example, the 0% band covers €0 to €24,192, and the 42% band runs from €136,860 to €555,650. This is due to the “income splitting” system (Ehegattensplitting), which often lowers the tax burden when partners earn different amounts.

Self-employed people face the same progressive scale but can claim business expenses. The marginal tax rate is the rate that applies to the last euro of income and depends on total taxable income.

What are tax classes and how do they affect your tax rate?

Tax classes (Steuerklassen) are mainly relevant for employees and influence how much wage tax is withheld each month. There are six classes. They affect monthly cash flow, but not the final annual tax amount once the tax return is processed.

Overview of tax classes:

• Class I: Single, divorced, widowed, or registered partners not in classes II, III, or IV.
• Class II: Single parents entitled to the single-parent allowance who do not live with another adult partner (application to the tax office is usually needed).
• Class III: For married couples when one partner earns much more or the other has no income. The higher earner uses class III, the other partner is placed in class V. Also applies to widowed persons in the year of death and the following year.
• Class IV: Standard class for married couples or registered partners both working and living in Germany, especially suitable if incomes are similar.
• Class V: Complement to class III: if one spouse chooses III, the other automatically gets V, which has higher monthly deductions.
• Class VI: For employees with more than one job (for the second and further jobs). It has the highest withholding rates.

Married couples can choose between a 4/4 combination or 3/5. A 3/5 split can increase the net income of the higher earner but may lead to an additional payment when filing the return if too little tax was withheld overall. It is possible to change tax classes, usually once per year until November 30. Major life events (marriage, divorce, death of a spouse, start of a second job) require changes to the tax class.

How are wage tax and withholding applied?

Wage tax (Lohnsteuer) is income tax collected directly from employees’ salaries. Employers calculate it each month and transfer it to the tax office.

The withheld amount depends mainly on the employee’s tax class and registered allowances, such as child allowances. For example, someone in tax class III will usually see less wage tax deducted than a person in class I with the same gross salary. However, the tax class only affects the timing of payments over the year. The final tax due is set during the annual assessment, based on the full year’s income and deductions.

Employers also withhold social security contributions and, if applicable, church tax and solidarity surcharge. This system guarantees a steady flow of money to the state and saves most employees from making separate tax prepayments.

What deductions and allowances can reduce taxable income?

German tax law provides many ways to reduce taxable income. These rules take into account work-related costs, family situation, and certain private expenses.

Important categories include:

• Work-related expenses (Werbungskosten): Employees can deduct costs such as tools, specialist clothing, and commuting. A lump-sum amount is automatically applied; if real costs are higher and can be proven, they can be fully deducted. From 2022, the lump-sum was raised to €1,200 per employee. Home office costs can also be claimed under certain rules (for example, from 2023, €6 per day, capped at €1,260 per year).
• Social security contributions: Mandatory contributions to health, pension, nursing care, and unemployment insurance (around 20% of gross income) are generally deducted before the tax base is calculated. Health and long-term care contributions are largely fully deductible; pension contributions are being phased in for full deductibility by 2025.
• Special expenses (Sonderausgaben): These include certain insurance premiums, church tax, and costs for advice on taxes. There is a lump sum, but higher actual costs can be claimed with evidence.
• Family-related allowances: Child allowances and certain education-related costs can reduce tax. For jointly assessed couples or single parents, some allowances are doubled or increased.
• Business expenses: Self-employed people and freelancers can deduct business-related costs, lowering their taxable profit.

These rules can lead to substantial tax savings, but the system is detailed, so many people use tax software, tax advisors, or wage tax help associations to claim all possible deductions.

What is the process for the annual income tax return?

The annual income tax return (Einkommensteuererklärung) balances what you have already paid through wage tax or prepayments with the final amount due for the year. This often leads to tax refunds for employees.

The tax year is the calendar year. For most taxpayers, the deadline to file is July 31 of the following year. If a tax advisor (Steuerberater) prepares the return, the deadline is usually extended to the end of February of the second year after the tax year. In special cases, further extensions are possible.

In the return, you declare all income sources plus deductions and allowances. Employees who only have one job and no complex additional income do not always have to file, but many still do because they often get a refund. People with multiple jobs, self-employed income, or certain other situations must file.

You can file using paper forms, the ELSTER online portal, commercial software, apps, or with the help of a tax advisor or wage tax assistance association (Lohnsteuerhilfeverein). The local tax office then checks the return and sends a tax assessment notice (Steuerbescheid) showing the final tax and any refund or extra payment. Extra tax is generally due within one month; refunds are usually transferred shortly after the assessment. The tax office may also set quarterly prepayments for people with significant income not subject to wage tax.

Surcharges and additional taxes on income

Besides regular income tax, there are extra charges that can apply. These include the solidarity surcharge and church tax. They help fund special purposes and reflect historical and social arrangements.

They can raise the total tax burden and are important to understand for a full view of what is withheld from income.

What is solidarity surcharge and who pays it?

The solidarity surcharge (Solidaritätszuschlag or “Soli”) is an extra tax on income tax. It was introduced in 1991 and later linked mainly to the costs of reunification and improving living conditions in the former East Germany.

For many years it was 5.5% of the income tax for all taxpayers. Since January 1, 2021, the charge has been greatly reduced for most people. Today, taxpayers with an income tax burden up to €19,950 (roughly equal to €73,463 taxable income) do not pay Soli if taxed separately. For jointly assessed couples the limit is about double: a tax burden up to €39,900 (about €146,926 taxable income).

Above these limits, the surcharge increases gradually. The full 5.5% applies only from higher income levels, around €105,500 taxable income for single filers and €211,000 for joint filers. The full rate also applies to capital income taxed at the flat rate and certain lump-sum taxed employment income. These amounts are adjusted from time to time. Today only the top share of earners, around 10%, still pays the full solidarity surcharge.

What is church tax in Germany?

Church tax (Kirchensteuer) is paid by members of certain religious communities with special public law status in Germany, mainly the Catholic and Protestant churches and Jewish communities. It is their main source of income for religious work, social projects, and cultural activities.

You pay church tax if you live in Germany and belong to a religious community that has the right to levy it (Körperschaft des öffentlichen Rechts). Your nationality does not matter; what matters is residence and membership. Church tax is calculated as a percentage of your income tax and is usually withheld directly from your wages by your employer.

The rate is:

• 8% of income tax in Bavaria and Baden-Württemberg
• 9% of income tax in all other states

You can stop paying church tax by formally leaving the church (Kirchenaustritt) at a local authority office. People below the basic exemption (for 2025: €12,096 taxable income) do not pay it. Church tax itself is considered a special expense and can be deducted from taxable income.

Some Muslim communities have public law status but do not charge church tax, so Muslims in Germany do not pay it. The state collects church tax on behalf of the churches and passes it on.

Other major taxes in Germany

Besides income tax and its surcharges, Germany has other important taxes that affect consumers, property owners, and businesses. These include VAT, corporation tax, trade tax, property taxes, inheritance and gift tax, capital income taxation, and motor vehicle tax.

Anyone who runs a business, buys real estate, or invests money in Germany should be aware of these taxes because they shape overall costs and returns.

What is value-added tax (VAT) and how does it work?

Value-added tax (VAT, Mehrwertsteuer or Umsatzsteuer) is a tax on most goods and services. Consumers encounter it with nearly every purchase, as it is included in the final price.

Businesses collect VAT from customers and pass it on to the tax office. They can deduct the VAT they themselves paid on purchases (input tax) from the VAT they charge, and only pay the difference. Businesses must submit periodic VAT returns (usually monthly or quarterly) and an annual VAT return.

The standard VAT rate in Germany is 19%. It applies to most goods and services that are not considered basic necessities or specially protected sectors.

Are there VAT exemptions or reduced rates?

Yes. Some goods and services are taxed at a reduced rate of 7%, and others are exempt from VAT altogether.

Reduced 7% rate often applies to:

• Certain basic food items
• Books, newspapers, and magazines
• Local public transport and some cultural services

Exempt from VAT are, for example:

• Exports and intra-EU supplies of goods
• Many medical services (e.g. by doctors)
• Most financial and insurance services
• Long-term rental of real estate
• Cultural services by public institutions (theatres, museums)
• Certain educational services
• Some voluntary or honorary services

Small enterprises can choose a special scheme if their turnover (including VAT) was no more than €17,500 in the previous year and is not expected to exceed €50,000 in the current year. They then do not charge VAT and cannot deduct input VAT.

Non-EU tourists can buy goods in Germany without VAT if they meet certain conditions (residence outside the EU, no long-term residence permit, export of goods in personal luggage within three months, and purchase value above €50). This is the “tax-free shopping” scheme.

What is corporation tax and who is subject to it?

Corporation tax (Körperschaftsteuer) is the equivalent of income tax for legal entities such as companies. It is charged on the profits of corporations (Kapitalgesellschaften) like GmbH (limited liability companies) and AG (public limited companies).

Sole traders and partnerships do not pay corporation tax; their business income is taxed as personal income of the owners. Corporations whose management or legal seat is in Germany are taxed on their worldwide profits. The standard corporation tax rate is 15%.

On top of corporation tax, companies pay a 5.5% solidarity surcharge on the corporation tax amount and a municipal trade tax. The total effective burden often approaches 30%, depending on the municipality. Some organizations, such as charitable foundations, church bodies, and certain sports clubs, may be exempt from corporation tax.

How does trade tax apply to businesses?

Trade tax (Gewerbesteuer) is a local tax charged on business activities carried out as a trade. It is a key income source for municipalities, reflecting the local costs of providing infrastructure and services to businesses.

The base rate is 3.5% of trade income, but each municipality sets its own multiplier (Hebesatz), usually between about 250% and 580%. This leads to effective trade tax rates roughly between 7% and 18.5%, depending on location.

Key points:

• All trades must file a trade tax return.
• The tax office calculates trade income and forwards it to the municipality.
• Freelancers (Freiberufler) such as doctors, lawyers, journalists, and many artists generally do not pay trade tax.
• Individuals and partnerships enjoy a tax-free allowance of €24,500 in trade income; corporations do not.
• Since 2008, corporations cannot deduct trade tax from taxable profit, but individuals and partners in partnerships can credit part of their trade tax against income tax.

What is real property tax?

Real property tax (Grundsteuer) is a local tax on property owners. Municipalities set the rates and use the revenue to fund local services such as schools, roads, and parks.

Property tax is usually paid quarterly. In 2018, the Constitutional Court ruled that the old system, based on very outdated property values from the 1960s (or 1930s in East Germany), was unconstitutional because it led to unfair differences between similar properties. A reform is now being introduced to update valuations and make taxation more equal across similar properties.

What is real property transfer tax?

Real property transfer tax (Grunderwerbsteuer) is charged when ownership of real estate changes hands. In theory, buyer and seller are jointly liable, but in practice the buyer normally pays.

Each federal state sets its own rate. The basic rate used to be 3.5%, but since 2011 most states have increased it. Many now charge between 4.5% and 5%, while some, such as North Rhine-Westphalia, Saarland, and Schleswig-Holstein, apply 6.5%. This means the final cost of buying property varies a lot between states.

There is also a “speculation tax” (Spekulationssteuer) on profits from selling property held for less than ten years, unless the property was used as the owner’s main home in the year of sale and the two previous years. For this tax, depreciation previously claimed is added back to the selling price to calculate the gain.

How are inheritance and gift taxes structured?

Inheritance and gift tax are governed by a single act. Both inheritances (after death) and gifts (between living persons) are taxed in a similar way. The tax rates range from 7% to 50%.

In Germany, the person receiving the asset pays the tax. The amount and rate depend on:

• The value of the inheritance or gift
• The family relationship between the giver/deceased and the recipient

Close relatives (spouses, children) benefit from higher exemptions and lower rates. Examples of exemptions:

In some cases (for example, family homes or business assets that remain in operation), up to 100% of the value can be exempt under certain conditions.

Germany has inheritance and gift tax treaties with several countries (such as Denmark, France, Greece, Sweden, Switzerland, and the United States) to avoid double taxation for cross-border estates and gifts.

How are capital gains taxed?

Germany does not have a single separate “capital gains tax” law. Instead, capital gains are mostly treated as part of income tax, with special rules, especially for investment income.

Since January 1, 2009, most investment income, including gains on shares acquired after December 31, 2008, is subject to a final flat withholding tax (Abgeltungsteuer) of 25% plus solidarity surcharge and, if applicable, church tax. For residents, if this withholding was correctly applied by the bank, the tax on this income is usually settled and does not have to be declared.

If certain capital income (e.g. from foreign banks) has not been taxed by withholding in Germany, it must be reported in the tax return. Taxpayers whose average personal tax rate is below 25% can opt to have investment income taxed at their lower personal rate. There is an annual tax-free allowance for investment income: €1,000 for singles and €2,000 for jointly assessed married couples.

Real estate gains are treated differently. If a property is sold within ten years of purchase, the profit is taxed at the normal progressive income tax rates, unless the property served as the main home in the year of sale and the two previous years. For some other private assets, gains are tax-free if the asset is held for more than one year. If income is generated from the asset, the relevant period can extend to ten years. Net investment losses can be carried forward and offset against future positive investment income, although special limits apply to share losses.

Which goods are subject to motor vehicle tax?

Motor vehicle tax (Kfz-Steuer) is an annual tax on owners of motor vehicles, including cars, motorcycles, trucks, trailers, and motorhomes.

For cars, the tax depends on:

• Type of engine (petrol or diesel; diesel usually higher)
• Engine size (cubic centimeters)
• Emission standard (Euro 1 to Euro 6)
• Presence of a particle filter in diesel cars
• First registration date
• CO₂ emissions for newer registrations

For vehicles registered before June 30, 2009, engine size was the main factor. For registrations from July 1, 2009, CO₂ emissions are also used in the calculation. The CO₂-free threshold has been lowered over time (e.g. 95 g/km for cars first registered from January 1, 2014). Purely electric vehicles receive a motor vehicle tax exemption for at least five years after first registration to support climate-friendly transport. The tax is usually due once per year.

Social security contributions and tax interplay

Germany has a far-reaching social security system that protects people against risks such as old age, illness, unemployment, and the need for long-term care. These systems are funded by mandatory contributions, which are separate from taxes but reduce net income and influence the tax base.

Knowing how these contributions work and how they interact with income tax is important for both employees and employers.

What social security contributions are mandatory?

Most employees in Germany must pay into the following five social insurance schemes:

1. Pension insurance (Rentenversicherung): Provides a retirement pension based on insured earnings and years of contributions.
2. Unemployment insurance (Arbeitslosenversicherung): Provides benefits for a certain time if you become unemployed and meet conditions such as minimum insurance periods and active job search.
3. Health insurance (Krankenversicherung): Covers basic medical treatment, many drugs, and therapies. Most employees are insured with statutory health funds.
4. Nursing care insurance (Pflegeversicherung): Helps cover costs when someone needs long-term care due to illness or age.
5. Accident insurance (Unfallversicherung): Covers accidents at work and occupational illnesses and helps with rehabilitation. The employer pays these contributions alone.

For the first four insurances, contributions are usually shared equally by employer and employee, up to annual income limits that change each year. For 2024, for example, employees and employers each paid 9.3% for pension insurance and 1.5% for unemployment insurance up to set ceilings. Health and nursing care insurance rates are split, but employees pay an extra supplementary rate that depends on their chosen insurer.

Social security contributions are normally paid directly by the employer to the insurance funds. Some people (for example, those covered by foreign systems under EU rules or social security agreements) may be exempt from certain contributions.

How do social insurance payments affect taxable income?

Mandatory social security contributions reduce taxable income and, in turn, income tax. In many cases, they are treated as deductible expenses.

In particular, contributions to statutory health, pension, nursing care, and unemployment insurance can be subtracted when calculating taxable income. In total, these payments often account for around 20% of gross income. For tax purposes:

• Since 2010, most contributions to statutory health and long-term care insurance are fully deductible (excluding small parts for sick pay benefits).
• Pension contributions are increasingly deductible, reaching full deductibility in 2025.
• If health and care contributions do not use up certain limits (€1,900 for single persons, €3,800 for couples), other insurance contributions (like unemployment insurance) can also be deducted up to that limit.

This link between social security and tax shows how Germany funds its welfare system while offering tax relief on these essential payments.

Double taxation agreements and relief

Many people and businesses today earn money in more than one country. Without special rules, this can lead to the same income being taxed twice. To avoid this, Germany has signed many double taxation agreements (DTAs) with other states.

These treaties set out where different types of income are taxed and provide relief if taxes are paid in both countries. This is important for cross-border workers, expatriates, international investors, and multinational companies.

How do double taxation treaties protect against being taxed twice?

Double taxation treaties (Doppelbesteuerungsabkommen) are agreements between Germany and other countries that coordinate taxation of cross-border income. Germany has DTAs with about 90 countries, based mainly on the OECD Model Tax Convention.

DTAs:

• Allocate taxing rights between countries for various types of income (employment, business profits, dividends, interest, royalties, pensions, etc.).
• Limit withholding tax rates on dividends, interest, and royalties paid across borders.
• Provide methods for relieving double taxation, usually by:
  • Exemption method: The residence country leaves certain foreign income tax-free (but may consider it for the tax rate).
  • Credit method: The residence country taxes the foreign income but grants a credit for foreign tax paid, up to the amount of domestic tax due on that income.
• Often cover inheritance and gift taxes and include rules for cooperation between tax authorities, including information exchange.

Foreign taxpayers can sometimes apply the DTA to reduce German tax at source, for example by using exemption certificates or refund procedures.

What is the impact of foreign income on German taxes?

The effect of foreign income depends mainly on whether you are a German tax resident and whether there is a DTA between Germany and the other country.

For residents, the worldwide income principle applies: all income is, in principle, taxable in Germany. If a DTA exists, it usually determines where the income is taxed and how Germany gives relief. Common situations are:

• Foreign income is exempt in Germany but may influence the German tax rate through the progression clause.
• Foreign income is taxable in both countries, but German tax is reduced by a credit for foreign tax paid (up to the amount of German tax that would apply to that income).

If no DTA exists, Germany may still grant unilateral relief by allowing a credit for foreign tax within certain limits.

For people moving in or out of Germany, foreign income earned before arrival or after departure can still affect the German tax rate on domestic income via the progression clause. Non-residents, on the other hand, are taxed only on German-source income; their foreign income is generally ignored for German tax.