The Million Dollar Tip - New Verdict

Tips are tax-free – or not? The Cologne Finance Court had to decide.

Frankfurt am Main

March 1, 2024

---

In a notable tax law case, an employee received a tax-free tip totaling more than €1 million from his company in recognition of his outstanding performance. This unusual reward led to a legal dispute with the tax authorities, as tips are generally tax-free under German income tax law. The case ended up before the Cologne Tax Court, case number 9 K 2814/20.

The court case

A company pays its employee a large tip as a token of appreciation for their contribution to the company's success. The tax authorities disagree and demand tax on the amount, leading to legal proceedings. The core of the dispute revolves around the question of whether tips, regardless of their amount, should remain tax-free.

The verdict

The Cologne Finance Court ruled in favor of the tax office and against the tax-free payment of tips. The judges of the 9th Senate argued that the law's primary intention was to support low-earning employees, not to exempt large amounts from tax.

What does the ruling mean?

This ruling raises considerable doubts regarding tax law. The tax exemption of tips is regulated by law. Section 3 No. 51 of the Income Tax Act (EStG) clearly states that tips are tax-free, regardless of the amount. The previous maximum limit of €1,224 has been abolished since 2002. The wording of the legal regulation is therefore clear.

Nevertheless, the Cologne Finance Court argues with an interpretation that, contrary to the clear wording of the law, relies on the legislature's intention. Tips—including their tax exemption—should be reserved for the low-wage sector, where tax-free tips fulfill an important revenue function.

From a tax law perspective, such an interpretation raises considerable concerns. In Germany, any tax may only be levied if it is regulated by law. The Cologne Finance Court's ruling does not do justice to this principle of legality in administration.