This article explains what the annual payroll tax adjustment is and what you need to look out for regarding payroll accounting in December.

Annual Payroll Tax Adjustment

What is the annual payroll tax adjustment?

Changes to an employee's personal circumstances, such as reductions in working hours or salary fluctuations, can result in discrepancies between their annual payroll tax and the monthly payroll tax deductions that have been withheld. The annual payroll tax adjustment ensures that excess tax that has been withheld is refunded.

Employers compare the annual payroll tax with the total of monthly deductions withheld. If there is a surplus, they refund that amount in accordance with S. 42b German Income Tax Act (EStG) and R 42b Payroll Tax Law (LStR).

Note 
If there is a deficit, employers do not claim negative amounts from employees; this is done by the tax authorities as part of the income tax return process.

Annual payroll tax adjustment vs. income tax return

People often confuse the annual payroll tax adjustment and annual income tax return. The annual payroll tax adjustment is filed by the employer. The annual income tax return, on the other hand, is filed by the employee. 

Requirements for the annual payroll tax adjustment

Employers with at least ten employees on 31.12. must complete an annual payroll tax adjustment if certain requirements are met. For employers with fewer than ten employees, the payroll tax adjustment is voluntary.

Employers must file a payroll tax adjustment if the following conditions are met:

• Employees have been continuously employed throughout the year.
• At the end of the year, they receive a salary from an active or previous employment period. 
• There are no grounds for an exemption.

An annual payroll tax adjustment can only be filed if employees were employed by the same employer for the entire calendar year. No adjustment applies if employees join or leave the company during the year.

Only periods for which payroll tax has been withheld in accordance with individual ELStAM attributes are recognized. Employees who work part-time as marginal employees on a flat-rate taxed salary are excluded from the annual payroll tax adjustment.

This does not apply to employees who retire during the calendar year. If they continue to receive an income in the form of a company pension or early retirement benefit from the same employer, a payroll tax adjustment may be performed.

Note 
In accordance with R 42b (1) Clause 1 No. 2 LStR, an annual payroll tax adjustment may also be performed if an employee received a salary exclusively from previous employment during the entire calendar year.

If, at the end of the calendar year, the tax authority was to reclaim the amounts refunded by the employer from the employee as part of a compulsory assessment, an annual payroll tax adjustment would be excluded in accordance with S. 42b (1) Clause 3 EStG.

No annual payroll tax adjustment applies in the following cases, among others: 

• The employee requests to be exempted.
• The employee was taxed according to tax class V or VI for the whole or part of the calendar year.
• The employee was taxed according to tax class II, III or IV for part of the calendar year.
• An allowance or additional amount was applied in the payroll tax calculation.
• The factor-based method was applied.
• The additional health insurance contribution changed during the year.
• The employee received benefits such as short-time work benefits, contributions to maternity benefits, maternity protection wages or compensation for loss of earnings in accordance with the Infection Protection Act during the adjustment year.
• The capital letter U is recorded in the payroll account.
• Employees for whom provisional lump sum amounts were only applied temporarily in accordance with S. 39b(2) Clause 5 No. 3 a to d EStG or for whom the contribution surcharge in accordance with S. 39b(2) Clause 5 No. 3 c applied in the adjustment year.
• Employees who, in the adjustment year, received income from international employment that was exempt from payroll tax under a double taxation treaty or under the progression proviso.

Deadline for completing the annual payroll tax adjustment

In the above cases, the employer must calculate the annual payroll tax adjustment on its own initiative. This must be done with the last payroll period of the adjustment year (December) at the earliest and with the February payroll period of the following year at the latest. The obligation to file an annual payroll tax adjustment is therefore in line with the obligation to file the payroll tax statement. 

Note 
Filing the electronic payroll tax statement finalizes the payroll tax deduction process for the previous year, and the annual payroll tax adjustment can then no longer be done as a matter of principle.

How to complete the annual payroll tax adjustment

The individual steps for reviewing the annual payroll tax adjustment are described below. They should only be completed if the above requirements are met.

In practice, the annual payroll tax adjustment is generally done with the December payroll. This is usually set up in your payroll software by default. A note on the payslip shows the relevant tax amounts.

Step 1: Determine the relevant annual payroll tax

Deduct the proportional tax allowance for mature employees (Altersentlastungsbetrag), the benefits allowance (Versorgungsfreibetrag) and the associated surcharge from the taxable gross annual salary (usually the same as the annual salary for the relevant year). Note that the following requirements must be met. 

The taxable gross annual salary comprises the entire gross earnings, including benefits in kind and one-off payments, according to the payroll account. Tax-free benefits and flat-rate taxed compensation do not count towards the taxable gross annual salary.

How to calculate the relevant salary: 

Note 
Compensation and entitlements for multi-year employment, such as severance packages, are not included in the annual salary unless requested by the employee. This provision is only applicable for 2024. From 2025, only apply the one-fifths method to income tax assessments.

Step 2: Determine the annual payroll tax and difference

Determine the annual payroll tax for the relevant annual salary. This calculation must be based on the employee's tax class for the most recent payroll period, i.e. the tax class applicable on 31.12.

How to calculate the annual payroll tax and difference:

Note 
If you apply an annual payroll tax adjustment to an employee, you also need to consider the solidarity surcharge and church tax, if applicable.

What documentation requirements apply to the employer? 

In accordance with S. 42b (4) EStG, you must show any payroll tax refunded as part of the annual payroll tax adjustment separately in your payroll accounts. 

In the payroll tax certificate, you only need to show tax deductions made as part of the annual payroll tax adjustment process.