Freelancer or Business: Which Are You, and What Does That Mean?

Why does classification matter?

Three things follow from this classification: whether you’re subject to business tax, where you need to register, and when your accounting obligations take effect.

Only those who operate a business within the meaning of the Income Tax Act are required to pay business tax (Section 2(1) of the Business Tax Act). A business is an activity that is self-employed and ongoing, undertaken with the intent to make a profit, and constitutes participation in general economic activity. It may not consist of agriculture or forestry, the practice of a liberal profession, or any other form of self-employment (Section 15(2) of the Income Tax Act). An activity is considered ongoing if it is intended to be repeated, and the intent to make a profit may also be a secondary purpose. The registration process varies: Anyone who starts a business must register it with the municipality (business registration pursuant to § 14 of the Trade Regulation Act (GewO)), and the information is forwarded from there to the tax office. Freelancers must report the commencement of their business directly to the tax office (§ 138(1) of the General Tax Code (AO)). The accounting thresholds under § 141 AO apply only to business operators.

What are "catalog" occupations and similar occupations?

The list is set forth in Section 18(1)(1) of the Income Tax Act (EStG). The list includes, among others, physicians, dentists, veterinarians, alternative practitioners, attorneys, notaries, certified public accountants, tax consultants, engineers, architects, economic and business consultants, journalists, photojournalists, interpreters, and translators. In addition, this includes self-employed scientific, artistic, literary, teaching, or educational activities.

"Similar occupations" are also included (sentence 2). The tax office determines whether an occupation is similar to one listed in the catalog based on established criteria (see list).

If you are supported by employees with specialized training, you are considered a freelancer if you perform managerial and independent work based on your own expertise (sentence 3). Classification as a freelance profession requires that you perform managerial and independent work on your own.

How are borderline cases classified: coach, web designer, influencer, consultant?

Job titles such as "coach," "web designer," or "influencer" do not appear in the law. The tax office asks about the nature of the work.

Web design, for example, is not listed in the catalog under Section 18 of the German Income Tax Act (EStG). It is assessed based on the most closely related comparable activity: software development. Developing system software is generally considered to be engineering-like in nature. For application software, this applies only if both of the following are true: You develop in an engineering-like manner—that is, involving planning, design, and supervision—and you have training comparable to that of an engineer. If you design user interfaces and implement off-the-shelf systems, neither of these conditions is met, and the activity is considered commercial. Pure design remains commercial, even with relevant training.

The same applies to consulting: “Consulting economists and business administrators” are listed in the catalog, but other types of consulting are not automatically included.

If you do both—freelance work and commercial activities—separate accounting is the norm for you as a sole proprietor. The activities are kept separate to the extent that this is possible according to generally accepted practice, even if certain factual and economic overlaps exist. If you have not kept them separate, an estimate will be made if necessary. The concept of “spillover,” whereby a commercial activity renders everything else commercial, applies to partnerships, not sole proprietors.

Activities are assessed as a single unit only if they are inextricably linked—for example, because you are responsible for a single, unified outcome. In that case, the determining factor is which activity defines the whole.

The purchase and sale of goods is foreign to freelance work and constitutes a commercial activity. Anyone who resells products in addition to providing consulting services thereby engages in a commercial component, which must be separated. Similarly, creators who generate income from a mix of advertising, sales, and their own content may, under certain circumstances, be engaged in multiple activities that fall under different classifications.

There is a separate post on how to classify Creators.

How much is the business tax, and what are the benefits of the tax exemption?

The starting point is the profit from business operations, adjusted for additions and deductions (Section 7 of the Trade Tax Act). This result is called “business income.” From there, it is calculated in four steps to arrive at the trade tax (§ 11 GewStG, § 16(1) GewStG).

Each municipality sets its own tax rate, which is why the trade tax varies from place to place. The rate must be the same for all businesses in the municipality. If the municipality has not set a higher rate, it is 280 percent. This is the minimum rate (Section 16 of the Trade Tax Act).

How is business tax credited against income tax?

Trade tax is credited against income tax to the extent that the latter is attributable to business income (Section 35(1), first sentence, No. 1 of the Income Tax Act (EStG)). There are three limits in this regard.

First, no more than four times the trade tax base. Second, the portion of income tax attributable to business income (sentence 2): The sum of positive business income divided by the sum of all positive income, multiplied by the applicable tax rate after deducting amounts under international treaties and after crediting foreign taxes. Third, the trade tax actually due (sentence 5).

With a tax base rate of 400%, the first and third thresholds coincide, and the credit amounts to exactly the trade tax. If the assessment rate is higher than that, a residual amount remains that is not credited. If it is lower, the amount would be four times higher than the trade tax; in that case, only the trade tax actually due is credited. Because the minimum assessment rate is 280%, there are municipalities where this occurs.

What happens if something is misclassified?

The tax office determines the classification. This is based on the information provided in the tax registration questionnaire, which describes the nature and scope of the activity (Section 138(1b) of the German Fiscal Code (AO)). If the tax office classifies an activity that was reported as freelance work as a business, it treats the income as income from business operations (Section 15 of the Income Tax Act (EStG)). Trade tax is then due to the extent that the trade income exceeds the exemption amount. This may also apply to previous years—and go back further than one might think.

The assessment period is four years. It begins at the end of the year in which the tax liability arose. If you are required to file a tax return, the statute of limitations does not begin until the end of the year in which you file the return, but no later than the end of the third year following the tax year. If you filed your return on time, you are therefore safe four years after the filing year. Without a return, the tax office can still take action up to seven years after the tax year. In cases of reckless underreporting, the statute of limitations is extended to five years; in cases of tax evasion, it is extended to ten years; in such cases, it can be up to thirteen years. That is why it’s worth clarifying the classification early on.

If you believe the classification is incorrect, you may file an appeal against the decision.