Set up an individual enterprise : Everything you need to know about taxes, costs and more

If you're considering self-employment or starting an individual company, here's everything you need to know about establishing one and what to consider regarding costs and taxes.

What is an individual company/sole proprietorship? 

By definition, an individual company is a business established by a single natural person. Once you become self-employed on your own, you are already operating as a sole proprietorship. It's important to note that only natural persons can establish a sole proprietorship, not legal entities such as a GmbH or a foundation.

As a sole proprietorship, you operate under your own name and on your own account, without any additional business partners or shareholders. You have full decision-making authority, do not need to coordinate with anyone, and are not subject to directives. Additionally, no other person is involved in profit distribution. However, being a sole proprietor means you also bear full responsibility and liability, including with your personal assets.

The individual company and its legal form

German company law divides companies into different legal forms. The following legal forms exist within sole proprietorships:

-        Registered traders

-        Small traders

-        Freelancers

Registered Merchants

This legal form applies to sole traders who operate a commercial business. According to the German Commercial Code, this is the case if the business operations are so complex and complicated that professional commercial accounting is required. The criteria for this legal form include:

-        Annual turnover depending on the respective industry

-        Amount of capital employed

-        Size and nature of business premises

-        Type and number of business transactions

-        Type of accounting

-        Number of employees

-        Provision and utilization of loans

If a sole proprietorship fulfils these criteria, the owner is obliged to have the individual company entered in the commercial register. The company name does not necessarily have to include the name of the managing director, but can be freely chosen. The company is also subject to double-entry bookkeeping, the obligation to prepare balance sheets and the annual inventory obligation.

Small Businesses

If the sole proprietorship does not require a commercial business operation, it falls under the legal form of a small business. In this case, the individual company does not need to be registered in the commercial register and is subject to the general provisions of the Civil Code as well as tax laws. Operators of small businesses are required to operate under their first and last names, but additional descriptions of activities are allowed. For small businesses, simple accounting and income-expenditure accounting are sufficient for profit determination.

Freelancer

This group of individual companies is not considered commercial traders and, therefore, are not liable to pay trade tax. Freelancers are also not required to register their sole proprietorship in the commercial register. Similar to small business owners, this legal form only requires simple accounting and income-expenditure accounting for profit determination.

Not all professional groups are eligible for this legal form. To benefit from the advantages of being a freelancer, self-employed individuals must engage in scientific, literary, artistic, educational, or teaching activities and possess corresponding professional qualifications or talent. The following professional groups, among others, can work as freelancers:

-        Architects

-        Doctors, Veterinarians, Naturopaths or Physiotherapists

-        Lawyers, Patent Attorneys, Notaries

-        (Surveying) Engineers

-        Auditors 

-        Tax Consultants

-        Journalists, Photojournalists, Interpreters and Translators

Ultimately, the tax office decides on the classification and registration of a sole proprietorship under this legal form..

How to establish an individual company 

There are several ways to establish an individual company:

1.      Register as a small business with the trade office. This information is passed on to the tax office as well as the Chamber of Industry and Commerce (IHK) or the Chamber of Crafts (HWK).

2.      If you want to use the legal form of registered merchants, you must register the sole proprietorship in the commercial register in addition to registering with the trade office.

3.      Freelancers must register the commencement of their activities with the tax office and apply for a corresponding tax number. They will automatically become sole proprietors.

Since 2021, individual company must also complete and electronically submit the tax registration questionnaire to the tax office within the first four weeks of commencing their activities.

Establishing an individual company – What Costs Are Involved?

There is no minimum capital required to establish an individual company. Costs for registration and membership in the IHK, HWK, or a comparable professional association are incurred at the time of establishment. The costs for business registration vary from place to place but typically range between €10 and €65. If the sole proprietorship is registered in the commercial register, the costs are higher, approximately €200 to €300.

Establishing an Individual Company – Tax Incurred

As the owner of an individual company, you are required to pay the following taxes:

-        Trade tax (not applicable to freelancers and small business owners who do not exceed turnover and profit thresholds)

-        Income tax (if the tax-free amount is exceeded)

-        Value added tax (depending on the amount of gross turnover, exemption is possible)

-        Wage tax (if you employ staff)

Trade Tax

Trade tax is levied on the turnover of the individual company and varies depending on the company's location. A tax-free allowance applies to individual companies - this is 24,500 euros per financial year. As freelancers are not considered tradespeople, they are generally exempt from trade tax.

Income Tax

You are required to pay income tax on the earnings generated by your sole proprietorship. There is an exemption threshold of €10,347 per year for this tax. The amount of income tax owed depends on the revenue of the business. The actual tax burden is determined through the income tax return, which may result in refunds or additional payments.

Value Added Tax (VAT)

Individual Companies must pay VAT on sales generated within the country. Depending on the type of service or product, either the reduced tax rate (7 percent) or the standard tax rate (19 percent) applies. If the gross turnover of an individual company did not exceed €22,000 in the previous year and is not expected to exceed €50,000 in the current business year, it may be exempt from paying VAT.

VAT is itemized separately from the net amount on invoices and is paid directly to the tax office through monthly or quarterly VAT returns. If the individual company paid VAT for professional purposes to other companies, it can claim a full refund of this input tax from the tax office.

FAQ

What legal form does an individual company have?

An individual company can take various legal forms: registered merchants, small business owners, or freelancers. These legal forms differ in terms of accounting and tax obligations, as well as whether the individual company needs to be registered in the commercial register.

What taxes does an individual company have to pay?

Depending on the legal form, turnover, and income, individual companies must pay trade tax, income tax, and VAT. Whether these taxes must be paid and their respective amounts depend on various factors, such as the location of the business, annual turnover and income, and specific tax exemption thresholds and reductions. This means that not all sole proprietorships are subject to trade tax, and sole proprietorships may also be exempt from VAT and income tax if they do not exceed certain thresholds.

What do I need to start an individual company?

Starting an individual company is relatively straightforward: there is no minimum capital required, and only registration with the trade office is necessary. For registered merchants, the business must also be registered in the commercial register. Freelancers only need to register their activity with the tax office and apply for a corresponding tax number..