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Tax-Free Income: What Does It Mean for Business Owners?VAT & input tax
VAT3 min read

Tax-Free Income: What Does It Mean for Business Owners?

As a general rule, all income from self-employed or employed work is subject to taxation. There are exceptions to this rule, however — these may include social benefits or flat-rate allowances for voluntary activities, for example. In this article we set out which types of income are not subject to tax, and examine the differences between the various categories of tax-free and non-taxable income.

ByKarsten Guhr · Managing Director & Tax AdvisorVerified article
#Tax-free#Income#Meaning

Tax-free income in the strict sense is exhaustively listed in § 3 EStG (Income Tax Act). The law's lengthy list includes, among others, various wage-replacement and social benefits. These include:

  • Sickness benefit (Krankengeld)
  • Insolvency benefit (Insolvenzgeld)
  • Short-time working allowance (Kurzarbeitergeld)
  • Unemployment benefit (Arbeitslosengeld)
  • Housing benefit (Wohngeld)

Many self-employed persons are also interested in these exemptions. Firstly, this concerns business owners who receive sickness benefit, among other payments, during their self-employed activity. This benefit is granted by the statutory health insurer as part of voluntary insurance cover.

In addition, some self-employed persons with low incomes apply for housing benefit or supplementary unemployment benefit (ALG 2). Secondly, many founders receive such benefits before starting their business. They finance their living costs with unemployment benefit, for example, before setting up a business from unemployment.

Also worth mentioning are the instructor's allowance (Übungsleitungspauschale) of 3,000 euros per year and the voluntary work allowance (Ehrenamtspauschale) of 840 euros per year. Many self-employed persons work as lecturers at universities of applied sciences or as coaches at sports clubs — these tax concessions may well apply to them.

In addition, there is the category of non-taxable income. This comprises income that does not fall under any category of income (Einkunftsart) and is therefore likewise free of tax. Typical examples for business owners are the start-up grant (Gründungszuschuss) and the investment allowance (Investitionszulage).

For all tax-free and non-taxable income, the state refrains from raising any tax claims. Neither income tax nor corporation tax is payable.

Some income, however, is subject to the progression clause (Progressionsvorbehalt). This applies to wage-replacement benefits such as the short-time working allowance, sickness benefit, and insolvency benefit. As a recipient you pay no tax on these amounts, but the benefits do increase the individual tax rate applicable to your other income.

For all tax-free income under § 3 EStG, the law prohibits the deduction of business expenses. If costs are incurred in this context, you may not claim them as business expenses. The position is different where the income is non-taxable — such as an investment allowance. In that case, you may claim all related expenditure as a deduction that reduces your taxable profit.

Some tax-free and non-taxable income must be declared in your tax return; other items need not be. Lay persons are frequently overwhelmed by these requirements. If you instruct a tax firm such as Guhr Steuerberatung, you do not have to deal with these and other questions yourself: we ensure your tax return is correct and provide you with many valuable tips at the same time.

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What types of tax-free income exist?
Typical tax-free income includes various wage-replacement and social benefits such as sickness benefit, the short-time working allowance, and unemployment benefit. Non-taxable income such as the start-up grant (Gründungszuschuss) is also tax-free.
Which income is subject to tax?
Self-employed persons pay tax on their business profit. Income from other categories may be added — for example from a part-time job subject to compulsory social insurance. No tax is payable on tax-free income, though where the progression clause applies, such income does increase the individual tax rate.
Where do I enter tax-free income in my income tax return?
It depends on the type of tax-free income. As a freelancer, you can state the instructor's allowance (Übungsleitungspauschale) in Appendix S (Anlage S), for example. If you received wage-replacement benefits as an employee, you enter these in Appendix N (Anlage AN). Some tax-free or non-taxable income, such as the start-up grant, does not need to be declared.

https://www.haufe.de/finance/haufe-finance-office-premium/steuerfreie-einnahmen_idesk_PI20354_HI1637691.html

https://www.haufe.de/finance/haufe-finance-office-premium/betriebseinnahmen-nach-estg-13-arten-der-betriebseinnahmen_idesk_PI20354_HI1477455.html

About the author

Karsten Guhr · Managing Director & Tax Advisor

Founder of the firm. Advising entrepreneurs and holding structures on tax planning, structuring and succession for 15+ years.

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