Personal Income Tax

What is personal income tax?

Personal income tax (German: Einkommensteuer) is the tax on the income of natural persons, that is, of individuals as opposed to companies. It is governed by the German Income Tax Act (Einkommensteuergesetz, EStG) and covers income from seven categories of income, such as salary, rent or investment income. The tax is levied on taxable income under a progressive tariff: the higher the income, the higher the tax rate.

A GmbH (German limited liability company) does not pay personal income tax but corporate income tax (Körperschaftsteuer) and trade tax (Gewerbesteuer) (taxes on earnings). Founders and shareholders are nevertheless affected by personal income tax in three places: on the managing director's salary, on profit distributions and on the sale of shares in the company.

Categories of income and calculation of taxable income

Only what can be assigned to one of the seven categories of income in Section 2(1) EStG is taxable:

• Income from agriculture and forestry, from a trade or business and from self-employment (profit income)
• Income from employment, from investment assets, from rental and leasing, and other income (surplus income)

For profit income, the profit is determined either by a balance sheet (comparison of business assets) or by a simple cash-basis profit calculation. For surplus income, receipts less income-related expenses (Werbungskosten) count, that is, the expenses necessary to earn the receipts.

Formula (simplified): taxable income = total income minus special expenses minus extraordinary burdens minus allowances, for example for children

Income tax tariff and tax rates

The tariff under Section 32a EStG leaves a basic allowance tax-free, which secures the subsistence minimum. In 2026 it amounts to EUR 12,348 for single persons. Thereafter the rate rises progressively from 14% to the top rate of 42%, which applies from EUR 69,879; from EUR 277,826 it is 45%. For spouses assessed jointly these amounts double (income splitting procedure). The thresholds change almost every year. Because the rate rises continuously, the average burden is always below the marginal tax rate, which applies to the last euro earned.

For shareholders, two special rules apply in addition to the standard tariff. Private investment income is subject to the flat-rate withholding tax (Abgeltungsteuer) of 25% (Section 32d EStG). Under the partial income method (Teileinkünfteverfahren), dividends and capital gains from shares in corporations are 60% taxable and 40% tax-exempt (Section 3 No. 40 EStG). Related expenses are likewise deductible at only 60%. A solidarity surcharge of 5.5% may be added to the tax: under the regular tariff, since 2021 only for higher incomes, but as a rule still on investment income taxed at the flat rate. Church members additionally pay church tax.

Tax return, assessment notice and advance payments

Personal income tax is collected in two ways. With deduction at source, the payer withholds it, for example as wage tax (Lohnsteuer) or capital gains tax (Kapitalertragsteuer) (withholding tax); both are forms of collecting personal income tax, not separate taxes. In the assessment procedure, the tax office (Finanzamt) sets the tax on the basis of the tax return. A person with a residence or habitual abode in Germany is subject to unlimited tax liability and in principle also pays tax on income earned abroad (Section 1(1) EStG). A person who neither lives nor habitually resides here is subject to limited tax liability on German-source income only. Separate main forms exist for the two cases, ESt 1 A and ESt 1 C.

Anyone obliged to file submits the return without tax advice by 31 July of the following year (Section 149(2) of the German Fiscal Code, Abgabenordnung, AO). If a tax adviser prepares it, a deadline of the end of February of the year after next applies; for 2025 it ends on 1 March 2027, because 28 February is a Sunday. The result of the assessment is the income tax assessment notice, against which an objection can be filed within one month. With it, the tax office usually also sets advance payments for the current year, due on 10 March, 10 June, 10 September and 10 December (Section 37 EStG).

Personal income tax for founders and shareholders

Managing director's salary

The salary of a shareholder-managing director gives rise to income from employment and is subject to wage tax withholding. For the GmbH it is a deductible business expense to the extent that it is reasonable. The unreasonable part is treated as a hidden profit distribution (verdeckte Gewinnausschüttung), that is, a benefit to the shareholder that tax law treats like a distribution. It increases the company's income and is taxed in the hands of the shareholder as investment income.

Profit distributions

Distributed profits have already been subject to corporate income tax and trade tax at the level of the GmbH. For shares held as private assets, the company additionally withholds capital gains tax of 25% plus solidarity surcharge; in principle, this settles the personal income tax. On application, the shareholder can instead opt for the partial income method. The prerequisite is a shareholding of at least 25%, or of at least 1% where the shareholder works professionally for the company (Section 32d(2) No. 3 EStG).

Sale of shares in the company

If a shareholder held at least 1% at any time within the last five years, the sale of their shares leads to income under Section 17 EStG. This is treated as income from a trade or business, but is not subject to trade tax, and is taxed under the partial income method. Below this threshold the flat-rate withholding tax applies. The threshold has a five-year look-back effect: a shareholder who has been diluted below 1% by funding rounds remains within the scope of Section 17 EStG during this period. If a founder holds their stake through their own GmbH, that GmbH sells the shares. No personal income tax arises in that case; the GmbH is taxed on only 5% of the gain. Personal income tax arises only when the GmbH distributes the proceeds to the founder (holding structure).

Sole proprietorships and partnerships

For business owners who are individuals, the profit is attributed directly to the owners and is subject to their personal income tax, regardless of whether it is withdrawn. Under Section 35 EStG, trade tax is credited against income tax on a flat-rate basis.

Worked example: personal income tax on salary, distribution and sale

The example is simplified: solidarity surcharge, church tax and social security contributions are disregarded, and the tariff is replaced by a single rate. A GmbH earns an additional profit of EUR 100,000 before tax. The founder is the managing director, and their personal marginal tax rate is 42%. The tax burden of the GmbH from corporate income tax and trade tax is assumed at 30% (as of 2026).

• Additional, reasonable salary: personal income tax 100,000 × 42% = EUR 42,000; EUR 58,000 remains
• Distribution: income taxes of the GmbH 100,000 × 30% = EUR 30,000; EUR 70,000 is distributed; flat-rate withholding tax 70,000 × 25% = EUR 17,500; EUR 52,500 remains

In this simplified case, EUR 5,500 more remains with the salary, because it reduces the profit of the GmbH and is taxed only once. With the solidarity surcharge, social security contributions and the corporate income tax rate falling from 2028, the comparison shifts; it is therefore calculated for each individual case.

Some years later, the founder sells their 30% stake, held as private assets, for EUR 3.0 million. The acquisition costs were EUR 10,000 and the disposal costs EUR 90,000. For the high gain, a rate of 45% is assumed for simplicity.

• Capital gain under Section 17 EStG: 3,000,000 minus 10,000 minus 90,000 = EUR 2,900,000
• Taxable under the partial income method: 2,900,000 × 60% = EUR 1,740,000
• Personal income tax: 1,740,000 × 45% = EUR 783,000
• Gain after tax: 2,900,000 minus 783,000 = EUR 2,117,000; tax burden on the gain: 783,000 / 2,900,000 = 27%

Had a long-established holding GmbH sold the stake, only 5% of the gain would have been taxable. The tax would have been 2,900,000 × 5% × 30% = EUR 43,500, around 1.5% of the gain. This advantage applies only as long as the proceeds stay in the holding company. If it distributes them, the founder's personal income tax follows.

Distinctions: personal income tax, corporate income tax and flat-rate withholding tax

• Corporate income tax (Körperschaftsteuer): the equivalent of personal income tax for corporations, as of 2026 at a uniform rate of 15%. A reduction by one percentage point per year from 2028, down to 10% in 2032, has been enacted. It burdens the profit of the GmbH, whereas personal income tax burdens the inflow to the shareholder.
• Flat-rate withholding tax (Abgeltungsteuer): a special tariff within personal income tax for private investment income, which replaces the progressive tariff.
• Inheritance and gift tax: taxes transfers without consideration, for example of shares in the company to the next generation. A gift of privately held shares does not, as a rule, trigger personal income tax; the donee takes over the donor's acquisition costs.

Common mistakes

• Confusing withdrawals with profit. For business owners who are individuals, the entire profit is taxed, even if only part of it has been withdrawn.
• Salary without a reasonableness check. Excessive remuneration of the shareholder-managing director is reclassified as a hidden profit distribution in a tax audit.
• Overlooking the look-back effect of the 1% threshold. Shareholders who have meanwhile fallen below 1% often wrongly assume the flat-rate withholding tax applies on a sale.
• No reserve for additional payments. A capital gain is followed by the additional tax payment and often by increased advance payments, which are missing from private liquidity planning.

Frequently asked questions

How is personal income tax calculated?

In three steps. The income from all categories is added up and reduced by special expenses, extraordinary burdens and allowances. The tariff under Section 32a EStG is applied to the taxable income determined in this way. Withholding taxes such as wage tax are deducted from the result; the remainder is payable, and any excess is refunded. The Federal Ministry of Finance (Bundesministerium der Finanzen) offers a tax calculator for estimates.

Does a GmbH pay personal income tax?

No. The GmbH pays corporate income tax with solidarity surcharge and trade tax. Personal income tax arises only at shareholder level, when the shareholder draws a salary, receives distributions or sells shares.

How is the sale of GmbH shares taxed?

By size of shareholding and holding structure: from 1% under Section 17 EStG using the partial income method, below that with the flat-rate withholding tax of 25%. If a corporation holds the shares, 95% of the gain is tax-exempt under Section 8b of the German Corporation Tax Act (Körperschaftsteuergesetz, KStG).

How are payments from virtual shares taxed?

As income from employment at the time of payout. The company withholds wage tax, and the partial income method does not apply (ESOP).

Does moving abroad trigger personal income tax?

For shareholdings of 1% or more, it can. The German Foreign Tax Act (Section 6 AStG) treats an emigration, under certain conditions, like a sale at current value, even though no proceeds flow. One prerequisite is, among others, a longer previous tax liability in Germany. The details belong in a tax review before the move.

The Roemer Capital view

For founders, what counts at the end of a sale is the amount after tax. In every sell-side mandate, we therefore work through the chain from purchase price via deduction items and distribution of proceeds to the net proceeds per shareholder. We align the tax assumptions with the client's tax adviser, who assesses the taxation itself.

Early in the process, we clarify whether the founders hold their shares privately or through a holding company, and who has exceeded the 1% threshold in the last five years. A change to the holding structure needs lead time; in an ongoing sale process there is, as a rule, no room for it any more.