Progressionsvorbehalt: How It Changes Your Tax Rate

The Corona pandemic has had an enormous, unprecedented impact on the German economy. By June 2020, half of all German companies applied for short-term work (Kurzarbeit) and the number of employees receiving short-term work benefits (Kurzarbeitergeld) was higher than ever before. Of course, many employees are wondering what kind of effect short-term work benefits can have on their taxes. As all employees receiving short-term work benefits are required to file a tax return in the following year, there is a bit of confusion about whether short-term work benefits are tax free – if they really are tax-free, why do they have to be reported in your tax return?

What is Progressionsvorbehalt?

First, the good news: Short-term work benefits really are tax-free. They are wage replacement benefits (Lohnersatzleistungen) financed by contributions to unemployment insurance and therefore, not subject to normal wage tax (Lohnsteuer). Progressionsvorbehalt refers to the fact that tax-free income – such as short-term work benefits – can increase your tax rate (Steuersatz). Although the benefits themselves are not taxed, they are added to your total income to determine your tax rate. The reason for this is “performance-based taxation,” which means the higher your income, the higher your tax capacity. Short-term work benefits increase your income, thus increasing your tax capacity.

Short-term work benefits are added to your taxable income which is the assessment basis for your tax rate. Depending on the amount of the short-term work benefits, you can slip into the income bracket (Einkommensstufe) of the next higher tax rate. The tax office (Finanzamt) includes your benefits when calculating the average tax rate for your income, and then your income without your benefits is taxed at this higher rate. This leads to additional tax payments (Steuernachzahlungen) for many short-term workers. Below, we’ve prepared a simplified example so that this concept can be easily understood.

Example Calculation of Short-Term Benefits

Let’s imagine a single employee in tax class 1 (Steuerklasse 1) earns a gross salary of 2,000 euros per month. In April 2020, his hours were cut to zero because his employer had no work for him − unfortunately, this would remain the case for the remainder of the year. The calculation of his tax rate for the 2020 assessment period would be as follows:

• Monthly gross salary = 2,000 euros
• Monthly net wage = approximately 1,400 euros
• For the first three months, the Employment Agency (Agentur für Arbeit) pays 60 percent of the lost net wage
  840 euros x 3 = 2,520 euros
• From the fourth to sixth month, the Employment Agency pays 70 percent of the lost net wage
  980 euros x 3 = 2,940 euros
• From the seventh month on, the Employment Agency pays 80 percent of the lost net wage (for the remaining 3 months of the year)
  1,120 euros x 3 = 3,360 euros
• Total gross income for 2020 = 6,000 euros
• Total short-term work benefits for 2020 = 8,820 euros
• Tentative taxable income = 14,820 euros
• 2020 tax rate with short-term work benefits = 7.02%
• 2020 tax burden with short-term work benefits = 421 euros
• 2020 tax rate without short-term work benefits = 0.00%
• 2020 tax burden without short-term work benefits = 0 euros
• Expected tax payment due to short-term work benefits = 421 euros

The tax rate of 7.02% is applied to the employee’s gross income of 6,000 euros, which leads to a tax burden of 421 euros.

To calculate how your short-term work will affect your taxes, use our short-term work benefits calculator.

The additional tax payments caused by Progressionsvorbehalt are particularly tough on many employees in Corona times. For this reason, it is important to deal with the issue of tax returns early on and continue keeping track of tax-deductible expenses in order to keep your taxable income as low as possible.

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How Has Corona Changed Short-Term Work?

Lockdowns based on the Infection Protection Act (Infektionsschutzgesetz) were imposed in order to contain the Corona pandemic. To safeguard as many jobs as possible, the government passed the “Act for Temporary Crisis-Related Improvements to the Regulations for Short-Term Work Benefits” (“Gesetz zur befristeten krisenbedingten Verbesserung der Regelungen für das Kurzarbeitergeld”). This law significantly simplifies access to short-term work, for example, only 10% of employees need to have reduced work hours to be eligible for short-term work (previously: one third of the employees). The Federal Employment Agency (Agentur für Arbeit) will also reimburse employers for social security contributions on short-term work benefits.

The amount in short-term work benefits that employees can receive has been raised due to the Corona pandemic. Employees who have lost at least 50% of their work will receive 70% (77% for parents) of their lost net wages from the 4th month receiving benefits and 80% (87% for parents) from the 7th month. These Corona-related changes took effect on March 1st, 2020 and are initially scheduled to expire at the end of June 2022.

Tip: Employers should inform their staff early about potential additional taxes that will be due as a result of wage replacement benefits.

Employees should still obtain sick notes stating they are unfit for work if they become ill. All short-term workers should be prepared for additional tax payments due to the impact wage replacement benefits have on their income tax calculation.

Did you receive short-term work benefits? File your tax return today!