The fifth rule of § 34 (1) EStG is a tariff advantage for extraordinary income. Such extraordinary income includes profits on disposal or cessation of operations. We explain how the fifth rule works and how you optimize the tax burden through forward-looking planning.

1st fifth regulation

1.1. Purpose of the fifth regulation

The principle of income tax is that of annual taxation, so that the annual period also determines the temporal scope of the progressive tariff. However, the problem is that the income often does not flow to the taxpayer regularly and not during the periods in which it is generated. Rather, remuneration or income often flows into a sum for several years. Then the progression usually leads to a disproportionate load. A regular and distributed inflow of income leads to a lower progressive tariff and thus a lower overall tax burden.

In order to compensate for this higher total tax burden, the Income Tax Act provides for tariff concessions and allowances for the so-called extraordinary income, which is based on accumulation of income. Increased burdens are to be corrected and the annual tax principle is to be systematically supplemented.

1.2. Overview of the fifth regulation

§ 34 (1) EStG regulates a tariff reduction for those incomes that flow in one tax section but are remuneration for the performance of several tax sections, so-called extraordinary income. This includes the profit from the sale of a holding. This reduction in tariffs leads to a tax reduction through the calculation of extraordinary income over five years. It is assumed that the remaining taxable income remains unchanged in all five years.

Extraordinary income is not a new type of income. The determination of income is also not fundamentally changed. Rather, it is a separate tax calculation for a particular type of income that can lead to a tariff reduction. Finally, Article 34(2) of the EStG lists the income that is eligible for the tariff reduction. Capital gains can be found there in number 1.

§ 34 EStG can be fully used by unlimited taxpayers. Spouses assessed together shall be treated jointly as one taxable person. In certain cases, however, a higher tax relief can be achieved by the separate assessment. Why we explain in the further course of the contribution.

2. Application of the fifth rule

2.1. the fifth rule applies to extraordinary income

Extraordinary is an unusual, significant and atypical process. Therefore, they must be distinguished from regular current income and from the increases in assets typically incurred in a type of income.

Only the enumeration of an income in § 34 paragraph 2 EStG does not mean, however, that there is also a right to the tariff reduction in § 34 paragraph 1 EStG. Rather, the income described there is usually based on unusual and rare transactions. The facts of § 34 (2) EStG, which include severance payments, for example, therefore indicate extraordinaryness. Capital gains and job gains (§ 34(2) no. 1 EStG) are based on termination of employment. These are always extraordinary in nature. For the other points of § 34 (2) EStG, however, the exceptionality according to the above-mentioned definition must be examined in individual cases.

2.2. Accumulation required

In addition, the income must be an accumulation of revenues that would have been distributed over several years under normal circumstances. In summary, extraordinary income is always one-off income, unusual for the respective type of income, which represents the combined result of several years.

2.3. Capital gains as extraordinary income

In the case of capital gains, tax progression is tightened because the taxpayer realizes hidden reserves of assets arising over several years in a marketing year. Revenue shall not be attributable to current profit. Only when this is not the case will extraordinary income be available.

In addition, the income from disposal must also represent an accumulation of income. However, this presupposes that all hidden reserves of the essential basis of operation are dissolved in a uniform operation. Accordingly, there must be a uniform full realisation of the hidden reserves in relation to the object of the sale. However, the hidden reserves are not always fully realised.