Arthur started his career as an IT consultant in 2013 and has now been independent for four years with a corporate company type. Although the first year was tough, since then, everything seems to be going very well, as his revenue and profits are rising sharply.
Arthur is struggling with his internal organisation, though. He is a numbers guy, but he does not have much patience for doing his taxes. Following a second reminder from the government, he figured out the tax returns for 2013 by himself.
Since he has already received second reminder for 2014, he decided to put all of his tax documents into a box and go to a tax consultant.
The tax consultant does his accounting and notes that Arthur has achieved the following revenue:
2013: 15.000 Euro gross revenue (10.000 Euro profit) 2014: 45.000 Euro (30.000 Euro) 2015: 70.000 Euro (50.000 Euro) 2016: 100.000 Euro (60.000 Euro)
Using the tax declaration from 2013, the tax authorities set the prepayments:
VAT: 0 Euro because of the the small business rule (Kleinunternehmerregelung) Income tax: Euro € because of the income tax threshold Commercial tax: Euro € because of the local tax threshold
As we can see, Arthur has not paid any prepayments taxes yet. Since the tax authorities did not know how the sales had developed, they did not ask him to pay either.
Now, in 2017, the tax declarations for 2014 and 2015 are urgently needed. For the given figures, the following payments are made:
VAT: 0 Euros because of the the small business rule (Kleinunternehmerregelung) Income tax: 3,900 Euros Local tax tax: 750 Euros
VAT: 8,000 Euro (the small business rule doesn’t apply any more with this revenues) Income tax: 9,400 Euros local tax: 3,600 Euros
Note: Tax rates and amounts are rounded to simplify the calculation.
Arthur has to catch up and pay the taxes owed for both 2014 and 2015, which comes to 24,650 euros. This really hurts with an annual income of 60,000 euro, but it doesn’t end here, see because Author still owes taxes for money earned in 2016 AND any prepayments owed in 2017.
But it gets much worse (this is not fictitious, every tax office will react like this)
As the tax office now has new numbers to go by, it will adjust what it expects in terms of prepayments.
VAT: Since the taxable revenues exceeds 7,500 Euro, monthly prepayments must now be submitted. Arthur will have a four-week deadline to submit all retrospective prepayments (welcome to Germany) for 2016 and all outstanding pre-registrations for 2017. If costs stay the same, this amounts to 11,400 Euro retrospective VAT advance payments for 2016.
Income tax: The prepayments for income tax are set at 2,350 Euros (one quarter of the last tax burden). For 2016, four subsequent advance payments are due, i.e. 9,400 Euros.
local tax: Here the same mechanism applies as for income tax. Tax prepayments of 3,600 Euros are due.
In total, Arthur will owe: 24,650 Euros in taxes for 2014 and 2015 24,400 Euros in pre-payments for 2016 In total, this means Arthur will have to pay 49,050 Euros for taxes. With an annual income of 60,000 Euros. With a deadline of four weeks.
To top it off, the tax consultant hands him a bill of 5,000 Euro to take home.
But the future seemed so bright...
The tax office is not squeamish. If not paid, they will send out 1-2 more reminders and then seize your bank account. Even if Arthur manages to pay his tax debts, which amount to over 80% of his annual income, the next advance payment for 2017 and the next final payment for 2016 will soon be waiting for him.
While this example is fictional,it is similar to the situation in which thousands of self-employed people find themselves, particularly, those whose sales and profits increased considerably year over year. Speaking from my own experience, I can tell you that you have to deal with fundamental questions at this point.
I have seen some entrepreneurs give up.
Most self-employed people are ashamed by situations like this and do not talk about it. After all, conventional wisdom says you (should) know that you have to save money each month for taxes. On top of that, entrepreneurs are subject to tough criticism in Germany when their business fails.
I firmly believe that it is very important to talk about such dangers and to draw attention to them.
The basic problem is procrastination. Simply handing in your tax declaration on the deadline isn’t enough - you need to get ahead of taxes and figure out how much you need to set aside for prepayments before they’re due. Otherwise, you can find yourself in for a nasty and expensive surprise.
Financial management following gut feeling is doomed to failure!
It would be ideal if you could know as soon as your money hits your bank account, how much money you can keep and how much you have to put aside for the state, avoiding entirely the invisible build-up of tax debt.
This is the basic idea of Kontist and this article outlines the reasons why I am 100% behind this idea. Anyone who has lived through a similar situation can confirm this.
Finally, a small best practice tip: It is good to know how much you have to pay once. But it is safer if you pay immediately, so as not to be tempted to spend the money.
If your sales increase, you can always tell your tax office and ask to raise the prepayments. For this, you should create a rough calculation and write how much you would like to pay.