Save taxes by converting individual companies into GmbH? Can it really be that simple? We say yes! You can save both long-term and short-term taxes. In the long term, the GmbH offers the tax advantage that it only has to pay about 30 % tax, while a successful sole proprietorship can mean taxation at a private level with a tax rate of up to 45 %. As a GmbH shareholder, apart from a possible managing director salary, you only get the profit via a likewise taxable profit distribution. For this purpose, the Treasury charges 25 % capital gains tax and any other charges. But the GmbH can also reinvest profits instead of paying dividends. And in the short term, the conversion of a sole proprietorship into a GmbH also saves taxes, because the income tax advance payments paid up to the conversion are refundable.

1st Conversion of individual companies into GmbH – Introduction

Successful individual companies are a problem for their owners. Now you might think that sounds absurd. You should be happy when the business is going great, right? Of course, we treat all honest individual entrepreneurs to their economic success. Yes, we even want to promote it as much as we can! Therefore, read now a post about how we help our clients to save taxes by converting from a sole proprietorship into a GmbH.

Basics for the conversion of individual companies into GmbH

2.1. Taxation of individual enterprises

Before we get into the matter, we still need a certain expedition equipment as a basis for our excursion into the tax optimization field. Let’s start with our statement that corporate success is a double-edged pleasure.

Yes, of course, you make a considerable profit if you rank success after success as a sole proprietor. But at the latest with the fluttering of the income tax assessment, the joy disappears. Because the more successful you are entrepreneurial, the more pleased the tax office. This is due to the progressive tax rate, according to which Germany levies the income tax. For example, if you have achieved an annual profit of EUR 500,000, then usually no possible co-investment or possible child allowances helps. Even in the case of special expenses and exceptional charges, there will probably be no way of looking for ways to reduce the so-called rich tax rate of 45%, which then falls to the top income share. In addition, there may also be a trade tax overhang, which must also be shouldered in cities and municipalities with a high trade tax rate.

2.2. Taxation of limited liability companies

The trick here is to convert the sole proprietorship into a GmbH or another corporation. This is because corporations, which also include corporations, are subject to corporate tax instead of income tax. And they tax profits completely differently.

The corporation tax is a flat-rate taxation at a tax rate of 15 %. So no matter what the profit, the tax is always 15%. Together with the trade tax, a GmbH is therefore usually in the range of 30% tax. Compared to a top earner among the individual companies, this is a tax advantage of a good 20%.

However, this is only half the truth. Because of the profit taxed by the GmbH, their shareholders have so far seen little (unless they have paid a managing director salary). Only through a profit distribution, the profit, partly or completely, flows to the private account of the shareholders, but with a deduction of 25% capital gains tax (possibly plus church tax and/or solidarity surcharge). In the end, you also end up with around 50% tax.

But the payment of a dividend is purely voluntary. Anyone who is satisfied with the managing director salary, on which income tax also applies, can save the profits in the GmbH. This is also called thesaurating. In addition, the alternative partial income system allows dividends to be taxed 40 % free of tax at private level. This is therefore particularly worthwhile for smaller distributions, because then the personal income tax rate is relatively cheap due to the progression. In any case, there is a prospect that the income tax will be more favourable than the flat-rate capital gains tax with a tax rate of 25 %.

3. How to retroactively convert the sole proprietorship into a GmbH

The fact that you can convert a sole proprietorship into a GmbH by simply integrating it into it at the start of the GmbH is already a relief. But it's even better. Because the legislator even allows a retroactive conversion of a sole proprietorship into a GmbH by up to eight months. Since most companies set the calendar year as the marketing year, it is therefore still possible to ensure in August of a year that the sole proprietorship is to be regarded as a GmbH from the beginning of the year. However, such a step must be taken actively at the beginning of the year. Because the preparations for this transformation take time.

Since you need a balance sheet at the conversion date for the conversion and you have to balance sheet anyway at the end of the past financial year, you can save yourself the preparation of an additional balance sheet and use the annual balance sheet instead. This saves costs. The conversion date is then of course the 1.1. of the year. But the preparation of the balance sheet for the annual accounts also requires time. The subsequent examination also requires time. According to experience, we can report that if everything works, everything is prepared for the conversion of the individual company into a GmbH in July at the latest. Then finally the notary appointment for conversion can take place. And from then on, the sole proprietorship has been considered a GmbH since the beginning of the year.

But how can you save taxes by converting from a sole proprietorship to a GmbH?

4. How to Save Taxes by Conversion to a GmbH

Sure, a GmbH pays less tax than a sole proprietor. But also by converting a sole proprietorship into a GmbH you can save taxes. This is because as a successful sole proprietor you have already made at least once one of the quarterly income tax advance payments during the year until the conversion. Of course, the amount of such an advance payment depends on the personal income tax rate of the taxable sole proprietor. The advance payments that a GmbH has to make are thus significantly lower.

But if there is no longer a sole proprietorship because the retroactive conversion into a GmbH took place during the year, then you can save taxes by having the advance payment of the income tax refunded. You get practically the difference between the prepaid income tax and the corporation tax, to which the GmbH also has to pay discounts in advance. In the case of high profits, this difference may well result in a considerable amount – to the advantage of the current GmbH shareholder.

Saving taxes by converting individual companies into GmbH – Conclusion

You can therefore save taxes both in the short term and in the long term by converting a sole proprietorship into a GmbH. The GmbH then saves future profits in order to reinvest them. This will promote the further growth of the company. This is much stronger than it would be possible for a sole proprietor after deducting all taxes. In this respect, the GmbH clearly has a considerable advantage over a sole proprietorship.

Many entrepreneurs start in Germany as individual entrepreneurs. This may often make sense at first, as long as the profit is still relatively low. But as soon as the annual profit comes close to about EUR 100,000, one should think about restructuring. A conversion of the sole proprietorship into a GmbH can be a first step in saving taxes. Tax savings should not be an end in themselves, but a prerequisite for further economic growth. Because who has no interest in reinvestment anyway and would rather use the entire profit for private living, that also gets along with a sole proprietorship.