Annual Tax Act 2026: The planned changes to the Income Tax Act

Five articles, staggered entry into force

The government draft of the Annual Tax Act 2026 amends the Income Tax Act in five amending articles with staggered dates for entry into force (Art. 32 of the Annual Tax Act 2026): Art. 1 takes retroactive effect as of 1 January 2020, in that the special depreciation allowance under section 7c of the Income Tax Act, which never entered into force, is not being pursued further in view of the arithmetic declining-balance depreciation [Absetzung für Abnutzung–AfA] for electric vehicles under section 7(2a) of the Income Tax Act. The retroactive effect is unobjectionable from a constitutional standpoint because the provision never produced any legal effects. Art. 2 is to enter into force on 1 January 2026, the substantive core package in Art. 3 enters into force on the day after promulgation, Art. 4 on 1 January 2027 and Art. 5 (sections 41b and 41c of the Income Tax Act) on 1 January 2029. The application provisions in section 52 of the Income Tax Act depart from this in several cases.

Basic wage for Sunday, public holiday and night-work premiums (section 3b(2) sentence 1 of the draft Income Tax Act)

The basic wage [Grundlohn] is defined by statute for the first time: The taxable regular wages not taxed at a flat rate under section 40 of the Income Tax Act to which the employee is entitled for the relevant regular working hours, plus the employer contributions exempt under section 3 no. 56 or no. 63 of the Income Tax Act in so far as they constitute regular wages. The conversion into an hourly rate and the cap at EUR 50 remain unchanged. Administrative practice is thereby given a statutory footing and the assessment base is conclusively limited to taxable wage components. The case law of the Federal Fiscal Court, which had also included tax-exempt future-security benefits [Zukunftssicherungsleistungen] – in that case contributions to a support fund [Unterstützungskasse] – in the basic wage, is thereby deprived of its basis (Federal Fiscal Court judgement of 10 Aug 2023, file ref. VI R 11/21, Federal Tax Gazette II 2024, p. 202). As a component of Art. 4 of the Annual Tax Act 2026, this new rule would apply for the first time from the 2027 wage payment period.

Interest-accrual period on corrections to balance sheet items (section 4(2a) of the draft Income Tax Act)

Retroactive events display procedural particularities by reason of the suspension of the commencement of the limitation period under section 175(1) sentence 2 of the Fiscal Code [Abgabenordnung–AO], but also by reason of the suspension of the commencement of the grace period for the full interest charge [Vollverzinsung] under section 233a(2a) of the Fiscal Code. The new section 4(2a) sentence 1 of the draft Income Tax Act clarifies that the correction of a carrying value determinative for the balance sheet as at the end of the preceding financial year which affects the profit of the following year does not trigger a divergent interest-accrual period under section 233a(2a) of the Fiscal Code, even where it constitutes a retroactive event within the meaning of section 175(1) sentence 1 no. 2 of the Fiscal Code.

Where the amendment of the previous year’s balance sheet is itself based on a retroactive event, for example where the “15% threshold” of section 6(1) no. 1a of the Income Tax Act is exceeded, a counter-exception applies. The interest-accrual period is then governed by that of the previous year (section 4(2a) sentences 2 and 3 of the draft Income Tax Act). The provision was not yet contained in the ministerial draft of the Annual Tax Act 2026 and enters into force on the day after promulgation.

Allocation of the purchase price for developed properties (section 6f of the draft Income Tax Act)

The allocation of an overall purchase price, which is central to the depreciation base, is laid down by statute for the first time: By way of section 9(5) sentence 2 of the draft Income Tax Act it also applies to the surplus income categories [Überschusseinkunftsarten] (section 2(2) sentence 1 no. 2 of the Income Tax Act). A contractual allocation is to be taken as the basis for taxation provided that it does not fundamentally fail to reflect the real value relationships and appears economically tenable (section 6f(1) of the draft Income Tax Act; Federal Fiscal Court judgement of 16 Sep 2015, file ref. IX R 12/14, Federal Tax Gazette II 2016, p. 397). The further limits – sham agreement and abuse of legal arrangements within the meaning of section 42 of the Fiscal Code – are, however, to be found only in the explanatory memorandum and not in the text of the provision. This has hardly any practical consequences: Sections 41(2) and 42 of the Fiscal Code apply in any event, so that the mention in the explanatory memorandum operates in a declaratory rather than a relieving manner.

Where a sustainable contractual allocation is lacking, the land value and the building value are to be determined separately and the purchase price allocated according to the ratio of the respective value shares (section 6f(2) of the draft Income Tax Act). Under section 6f(3) of the draft Income Tax Act, the Federal Ministry of Finance [Bundesministerium der Finanzen–BMF] provides a working aid [Arbeitshilfe] for a simplified allocation, the result of which may be taken as the basis for taxation. It constitutes a qualified estimate which may be rebutted by expert evidence – what is required is a valuation report prepared following a personal on-site inspection by an expert who is publicly appointed and sworn or certified in accordance with DIN EN ISO/IEC 17024. That is remarkable, because the Federal Fiscal Court had denied the earlier working aid any suitability as a basis for determining value (Federal Fiscal Court judgement of 21 Jul 2020, file ref. IX R 26/19, Federal Tax Gazette II 2021, p. 372). Section 6f of the draft Income Tax Act is to apply for the first time to developed properties acquired on the basis of a binding contract of obligation [obligatorischer Vertrag] concluded after the day of promulgation of the Annual Tax Act 2026 (section 52(14b) of the draft Income Tax Act).

First place of work: 24 months in Germany (section 9(4) sentence 3 of the draft Income Tax Act)

The period after which a permanent assignment is to be assumed is reduced domestically from 48 to 24 months. For assignments abroad it remains at 48 months. Fixed-term assignments of more than 24 and up to 48 months hitherto gave rise to work away from the first place of work [Auswärtstätigkeit] with a deduction of travel expenses, whereas in future they will give rise to a first place of work with no more than the commuter allowance [Entfernungspauschale].

The new rule is to apply to assignments determined after 31 December 2026 (section 52(16b) sentence 2 of the draft Income Tax Act). For assignments determined up to that date, the previous version continues to apply (section 52(16b) sentence 3 of the draft Income Tax Act). The extension of a fixed-term assignment counts as a new assignment (section 52(16b) sentence 4 of the draft Income Tax Act). Existing cases will therefore migrate into the new law successively.

Unreduced child allowances for children in other EU/EEA states (section 32(6) sentence 4 and section 33a(2) sentence 2 of the draft Income Tax Act)

Following the judgement of the Court of Justice of the European Union of 16 Jun 2022 (file ref. C-328/20), the indexation of family benefits by reference to purchasing power in the child’s state of residence infringes Regulations (EC) No 883/2004 and (EU) No 492/2011 and constitutes indirect discrimination. Since the child allowances are granted in the same amount for every child and without a means test, that reasoning can be transposed. The reduction is therefore confined to children without a residence in an EU or EEA state. As a consequential amendment, the training allowance [Ausbildungsfreibetrag] under section 33a(2) of the Income Tax Act is likewise granted without reduction. Both amendments are to be applied in all open cases (section 52(32) sentence 6 and section 52(33d) of the draft Income Tax Act).

Rate reduction and partial exemptions under investment tax law (section 34(2) no. 1 of the draft Income Tax Act)

In order to avoid double benefits, the rate reduction [Tarifermäßigung] under section 34(2) no. 1 of the Income Tax Act excludes gains on disposals that are already partially exempt. To date, this exception is to be found only in relation to the partial-income method [Teileinkünfteverfahren] (section 3 no. 40 of the Income Tax Act).

In future, gains subject to the partial exemption under section 20 of the Investment Tax Act [Investmentsteuergesetz–InvStG] in conjunction with section 21 of the Investment Tax Act are also to be covered, as are the situations set out in section 49(1) of the Investment Tax Act (investor equity gains, investor treaty gains and investor partial-exemption gains). In the case of disposals of a business with investment fund units held as business assets, the composition of the gain on disposal will therefore have to be documented more precisely in future. The new rule is to be applied for the first time for the 2027 assessment period.

Withholding tax on investment income and deduction of tax at source for persons with non-resident tax liability (sections 50b and 50c of the draft Income Tax Act)

Section 50b of the draft Income Tax Act confers on the tax authorities, and in particular on the Federal Central Tax Office [Bundeszentralamt für Steuern], the power to verify, as to their basis and their amount, the particulars to be transmitted under sections 45b and 45c of the Income Tax Act at the custodians and intermediate custodians involved. Covered is investment income within the meaning of section 43(1) sentence 1 no. 1a and no. 2 sentence 4 of the Income Tax Act which accrues after 31 December 2026. The amendments enter into force on the day after promulgation.

The exemption threshold [Freigrenze] for waiving the deduction of tax at source in the case of income within the meaning of section 50a(1) no. 3 of the Income Tax Act (licensing of rights) is to be raised from EUR 10,000 to EUR 100,000 (section 50c(2) sentence 1 no. 2 of the draft Income Tax Act), because the increase effected by the Growth Opportunities Act [Wachstumschancengesetz] of 2024 likewise brought the target group no perceptible relief. The remaining conditions remain unchanged.

In addition, the exemption threshold for small fees in respect of performances within the meaning of section 50a(1) no. 1 of the Income Tax Act is raised from EUR 250 to EUR 500 per performance (section 50a(2) sentence 3 of the draft Income Tax Act). This too applies to amounts accruing after 31 December 2026.

Moving in the opposite direction, the exemption procedure for investment income within the meaning of section 43(1) sentence 1 no. 1a of the Income Tax Act – shares held in collective or separate custody – is excluded (section 50c(2) sentence 6 of the draft Income Tax Act), in order to deprive transfers around the dividend record date of their basis. In future, withholding tax on investment income of 25 per cent will initially be retained. Relief will be granted only upon assessment or under section 50c(3) of the Income Tax Act, which means a perceptible cash-flow disadvantage for the major shareholders concerned. Both apply to amounts accruing after 31 December 2026. Exemption certificates already issued cease to have effect at that date at the latest (section 52(47a) sentences 3 and 4 of the draft Income Tax Act).

Outlook: The future shape of the income tax rate schedule (section 32a of the draft Income Tax Act in the Income Tax Reform Act 2027)

In the “Income Tax Reform Act 2027”, which is currently available as a “ministerial draft”, the income tax rate schedule [Einkommensteuertarif] under section 32a(1) of the Income Tax Act is also, among other things, to be amended: The basic tax-free allowance [Grundfreibetrag] under section 32a of the Income Tax Act is to rise from the current EUR 12,348 to EUR 12,564 (section 32a(1) sentence 2 no. 1 of the draft Income Tax Act; from the 2028 assessment period: EUR 12,900). The marginal tax rate of 42 per cent is to take effect from EUR 70,601 (previously: EUR 69,879), while the current highest marginal tax rate of 45 per cent is to apply from as little as EUR 250,000 of taxable income (“tax on the rich” [Reichensteuer]; previously: EUR 277,826; section 32a(1) sentence 2 no. 5 of the draft Income Tax Act). From EUR 280,000 of taxable income, a new top tax rate of 47 per cent is to apply (section 32a(1) sentence 2 no. 6 of the draft Income Tax Act).

The draft further provides for an increase in the standard employee allowance [Arbeitnehmerpauschbetrag] in section 9a sentence 1 no. 1 (a) of the draft Income Tax Act to EUR 1,430 (previously: EUR 1,230), as well as a reduction in the percentage (from 20 per cent to 15 per cent) and hence also in the maximum amount where tradesmen’s services for renovation, maintenance and modernisation measures are used (section 35a(3) of the draft Income Tax Act) to EUR 900 (previously: EUR 1,200).

As a result of the planned change to the rate schedule, the relationships between the individual tax rates in the law on taxes on income [Ertragsteuerrecht] change, particularly in the case of taxable income from EUR 280,000: In this income range, the solidarity surcharge is payable in full – the phase-in zone [Milderungszone] of section 4 sentence 2 of the Solidarity Surcharge Act [Solidaritätszuschlaggesetz–SolZG] having long since been exceeded – so that the top tax rate (marginal burden) amounts to at least 49.59 per cent. Any church tax (section 51a of the Income Tax Act) is payable in addition.

The flat withholding tax rate [Abgeltungsteuer] of 25 per cent under section 32d(1) sentence 1 of the Income Tax Act appears considerably more favourable in that respect, whereas any exceptions to that rate (section 32d(2) of the Income Tax Act; section 10(2) sentence 4 of the Foreign Tax Act [Außensteuergesetz–AStG]) have more negative effects than hitherto. The stepwise reduction of the “retained-earnings tax rate” [Thesaurierungssteuersatz] (section 34a(1) sentence 1 of the Income Tax Act) to 25 per cent (from the 2032 assessment period), which has already been implemented in law, likewise appears in a more favourable light in that respect. The option to be taxed as a corporation available to various transparently taxed entities (section 1a of the Corporation Tax Act [Körperschaftsteuergesetz–KStG]) also becomes a more appealing choice, particularly since the statutory corporation tax rate (section 23(1) of the Corporation Tax Act) falls stepwise to 10 per cent by the 2032 assessment period.

Recommended action

Real estate investors should review ongoing acquisition processes with regard to the date on which the contract is concluded: From that date, section 6f of the draft Income Tax Act applies, with a statutorily anchored working aid and formalised requirements for evidence in rebuttal. Employers should determine fixed-term assignments of more than 24 and up to 48 months by 31 December 2026 in order to make use of the grandfathering. It should be noted that the subsequent extension of such an assignment counts as a new assignment (section 52(16b) sentence 4 of the draft Income Tax Act) and causes the grandfathering to lapse again. In the case of children resident in the EU or the EEA, assessment notices should be kept open. Groups making license payments abroad benefit from the exemption threshold of EUR 100,000. The new top tax rate of 47 per cent and the earlier onset of the “tax on the rich” also make alternative arrangements under section 34a of the Income Tax Act or section 1a of the Corporation Tax Act appear attractive. Amendments in the course of the further legislative procedures remain to be seen.