Additional Taxable Wages for Lawyers in Germany

Due to the issuance of a recent decree by the German Tax Authorities, lawyers employed in Germany will likely have their taxable wages increased by the imputation of the firm's payment of certain insurance contracts. However, with the right planning, the amount imputed to these attorneys can be limited to a nominal amount.

In its decree of July 22, 2010, (the “decree”) the Berlin Finance Ministry instructed taxpayers to treat professional indemnity insurance premiums (hereinafter “premiums”) paid by a law firm for an employed lawyer as a part of the employee's taxable wages. Moreover, according to the nationwide standardized approach of the German state tax authorities, if a law firm has only one insurance policy in place, amounts paid to the insurer cannot be divided between the statutory minimum insurance amount paid to cover an attorney's professional indemnity insurance and the excess paid for other insurance coverage. Thus, lawyers at German firms may face having even more additional compensation imputed to them.

Tax offices in other German states have received similar instructions. Therefore, the issue is not confined to Berlin and is of national importance in Germany. Payment of premiums by employers is already an issue during wage tax audits.

The decree reflects the ongoing development of relevant case law regarding the taxation of fringe benefits of employed lawyers. These cases have clarified that since the Federal Lawyers Act foresees that each lawyer is personally obliged to maintain a minimum amount of professional indemnity insurance, such insurance is contracted not only for the benefit of the employer firm but also for the benefit of the employed lawyer and, therefore, qualifies as a fringe benefit if paid by the firm.

As mentioned above, of particular interest in the decree is the statement that when there is only one insurance policy in place for the law firm and its employees, the amount of the fringe benefit is not limited to the cost for the statutory minimum insurance amount for each employed lawyer. Instead, costs in excess of the minimum insurance amount must be divided equally amongst all lawyers (partners and employed lawyers), and the payment of the employed lawyers' premiums should be classified as taxable wages. Given the insurance structure of many law firms in Germany, this can easily amount to the imputation of several thousand Euros annually per lawyer instead of the approximately '150 cost for each attorney's minimum professional indemnity insurance.

A Misinterpretation?

Some tax advisers in Germany have expressed their opinion that the Berlin Finance Ministry misinterpreted relevant German Tax Court judgments in its decree. Those cases referred to so-called “Scheinsozien,” i.e., non-equity lawyers who are employed by the firm but are treated as partners in third-party relations (due to their names on the letterhead, business cards, etc.). The court's rulings seem justifiable with respect to professional indemnity insurance for a “Scheinsozius,” since the benefits from such insurance are not only in favor of the law firm but also the respective lawyer. On the contrary, it is questionable whether this reasoning should also be applicable to associates and other employed lawyers. Generally, only the law firm, and not the employed lawyer, can be held personally liable for any negligence in the lawyer's professional capacity. Moreover, even if an employed lawyer is allowed to work on his/her own clients outside of the law firm, the firm's professional indemnity insurance does not provide him/her any additional benefit because those policies are usually limited to acts within his/her professional capacity within the law firm.

Minimizing the Impact

As a result of this decree, there is a considerable risk that the German tax offices will treat premiums as a fringe benefit and increase the employed lawyer's taxable wages. One approach for minimizing the impact of this imputation is for firms to enter into separate insurance contracts ' one for the firm, and another for employees covering only their statutory minimum insurance. In doing so, the firm should decrease the likelihood that the local tax office will seek to impute additional income beyond the approximately '150 cost for each attorney's minimum professional indemnity insurance.

Stanley Kolodziejczak, a member of this newsletter's Board of Editors, is co-chair of the Law Firm Services group of PricewaterhouseCoopers LLP and has more than 25 years of business, tax and accounting experience. His current experience is working with law firms that are facing the challenges of growth in a changing global market. He can be reached at 646-471-3160 and [email protected]. Nancy Regan is a director in the Law Firm Services group with 14 years of experience as an attorney in and around global law firms. She can be reached at 646-471-6104 and at [email protected].

Due to the issuance of a recent decree by the German Tax Authorities, lawyers employed in Germany will likely have their taxable wages increased by the imputation of the firm's payment of certain insurance contracts. However, with the right planning, the amount imputed to these attorneys can be limited to a nominal amount.

In its decree of July 22, 2010, (the “decree”) the Berlin Finance Ministry instructed taxpayers to treat professional indemnity insurance premiums (hereinafter “premiums”) paid by a law firm for an employed lawyer as a part of the employee's taxable wages. Moreover, according to the nationwide standardized approach of the German state tax authorities, if a law firm has only one insurance policy in place, amounts paid to the insurer cannot be divided between the statutory minimum insurance amount paid to cover an attorney's professional indemnity insurance and the excess paid for other insurance coverage. Thus, lawyers at German firms may face having even more additional compensation imputed to them.

Tax offices in other German states have received similar instructions. Therefore, the issue is not confined to Berlin and is of national importance in Germany. Payment of premiums by employers is already an issue during wage tax audits.

The decree reflects the ongoing development of relevant case law regarding the taxation of fringe benefits of employed lawyers. These cases have clarified that since the Federal Lawyers Act foresees that each lawyer is personally obliged to maintain a minimum amount of professional indemnity insurance, such insurance is contracted not only for the benefit of the employer firm but also for the benefit of the employed lawyer and, therefore, qualifies as a fringe benefit if paid by the firm.

As mentioned above, of particular interest in the decree is the statement that when there is only one insurance policy in place for the law firm and its employees, the amount of the fringe benefit is not limited to the cost for the statutory minimum insurance amount for each employed lawyer. Instead, costs in excess of the minimum insurance amount must be divided equally amongst all lawyers (partners and employed lawyers), and the payment of the employed lawyers' premiums should be classified as taxable wages. Given the insurance structure of many law firms in Germany, this can easily amount to the imputation of several thousand Euros annually per lawyer instead of the approximately '150 cost for each attorney's minimum professional indemnity insurance.

A Misinterpretation?

Some tax advisers in Germany have expressed their opinion that the Berlin Finance Ministry misinterpreted relevant German Tax Court judgments in its decree. Those cases referred to so-called “Scheinsozien,” i.e., non-equity lawyers who are employed by the firm but are treated as partners in third-party relations (due to their names on the letterhead, business cards, etc.). The court's rulings seem justifiable with respect to professional indemnity insurance for a “Scheinsozius,” since the benefits from such insurance are not only in favor of the law firm but also the respective lawyer. On the contrary, it is questionable whether this reasoning should also be applicable to associates and other employed lawyers. Generally, only the law firm, and not the employed lawyer, can be held personally liable for any negligence in the lawyer's professional capacity. Moreover, even if an employed lawyer is allowed to work on his/her own clients outside of the law firm, the firm's professional indemnity insurance does not provide him/her any additional benefit because those policies are usually limited to acts within his/her professional capacity within the law firm.

Minimizing the Impact

As a result of this decree, there is a considerable risk that the German tax offices will treat premiums as a fringe benefit and increase the employed lawyer's taxable wages. One approach for minimizing the impact of this imputation is for firms to enter into separate insurance contracts ' one for the firm, and another for employees covering only their statutory minimum insurance. In doing so, the firm should decrease the likelihood that the local tax office will seek to impute additional income beyond the approximately '150 cost for each attorney's minimum professional indemnity insurance.

Stanley Kolodziejczak, a member of this newsletter's Board of Editors, is co-chair of the Law Firm Services group of PricewaterhouseCoopers LLP and has more than 25 years of business, tax and accounting experience. His current experience is working with law firms that are facing the challenges of growth in a changing global market. He can be reached at 646-471-3160 and [email protected]. Nancy Regan is a director in the Law Firm Services group with 14 years of experience as an attorney in and around global law firms. She can be reached at 646-471-6104 and at [email protected].