Key Points of the Reform

To provide relief for low- and middle-income earners, the basic exemption, the child exemption, child benefits, and the employee flat-rate allowance are to be increased by approximately 200 euros to about 1,430 euros. In addition, the second tax bracket is to be flattened so that the tax burden for many
workers rises more gradually. At the same time, the flat tax rate for “minijobs” is to be raised from the current 2 percent to 5 percent, and the upper limit for tax-favored Sunday, holiday, and night shift premiums is to be increased, so that these tax benefits will apply in the future up to an hourly wage of 75 euros.

The top tax rate of 42 percent remains unchanged but will apply only to a slightly higher taxable income of 70,600 euros. To offset the costs, the so-called “wealth tax” will be expanded; that is, in the future, a 45 percent income tax rate will apply to taxable income of 250,000 euros or more, and a 47 percent rate will apply to taxable income of 280,000 euros or more.

Significant Impact on Sole Proprietorships and Family-Owned Businesses

For the BDI, this issue is highly relevant with regard to small and medium-sized enterprises (SMEs) and partnerships, as these entities pay taxes on their profits according to the income tax rates applicable to their partners. In this context, income tax is not merely a personal tax but serves as the primary corporate tax. Partnerships are already subject to a very high tax burden, which creates a competitive disadvantage in the international marketplace. An increase in the top income tax rate would effectively result in the taxation of profits by the partners in partnerships at a rate of approximately 50 percent (the top tax rate plus the solidarity surcharge amounts to a 49.6 percent tax burden).

An increase in the top income tax rate would affect an estimated 70 percent of business activities (IW Policy Paper 5/2026). Small and medium-sized enterprises and family-owned businesses, in particular, would therefore face an additional burden from the increase in the top income tax rate, as these companies are primarily organized as partnerships. This creates a barrier to investment and hinders the accumulation of equity and reserves in Germany.

Tax Simplification and Improvement of the Option Model by Fall 2026

In addition to the income tax reform, it was announced that proposals for further tax simplification, including an improvement to the option model, would be bundled by fall 2026. In practice, the option model has so far been used by less than one percent of partnerships in Germany, and only through legislative amendments can the option model fulfill its function as a truly legal-form-neutral taxation alternative. Specifically, the lock-up period regulations should be revised and made more flexible; practical regulations regarding special business assets should be created; and the right to revert to transparent taxation, as well as loss carryforward and the ability to be treated as a controlled subsidiary, should be improved. However, to reduce the bureaucratic burden on small and medium-sized enterprises (SMEs) and partnerships and to incentivize investment, it is also imperative to improve the procedure for taxing retained and reinvested profits under Section 34a of the Income Tax Act (EStG). To this end, the tax incentive for retaining earnings should be made attractive to SMEs as well; the order of use should be made more flexible; obstacles to restructuring should be removed; and the tax procedure should be simplified and digitized. Furthermore, the reform of in-kind benefits and numerous measures for the structural reform of corporate taxes are long overdue and should be implemented promptly in this context.

Outlook

The adopted income tax reform is only a first step—however, further steps will be necessary to strengthen Germany’s competitiveness as a business location in the long term. From the business community’s perspective, substantial relief for partnerships must be provided through the complete abolition of
the solidarity surcharge, a fundamental overhaul of the option model and the taxation of retained earnings in partnerships (Section 34a of the Income Tax Act), as well as further measures to modernize corporate taxes.