Why Business Assets Receive Special Treatment
Germany is famously a nation of family-owned businesses (Familienunternehmen). The Mittelstand -- small and medium-sized enterprises that form the backbone of the German economy -- is overwhelmingly family-owned and frequently passed from one generation to the next. Without special tax exemptions, the inheritance tax burden on a business transfer could force heirs to sell or liquidate the business to pay the tax, destroying jobs and economic value.
Recognizing this, the German legislature introduced extensive exemption rules for business assets in the Erbschaftsteuergesetz. These rules were significantly reformed in 2016 following a Federal Constitutional Court ruling, and the current framework provides two levels of exemption: the standard exemption (Regelverschonung) at 85% and the optional full exemption (Optionsverschonung) at 100%.
The Standard Exemption (Regelverschonung): 85% Tax-Free
Under the standard exemption, 85% of the value of qualifying business assets is exempt from inheritance or gift tax. The remaining 15% is taxable but benefits from an additional allowance (Abzugsbetrag) of 150,000 EUR, which phases out for estates with taxable business assets above 150,000 EUR.
To qualify for the standard exemption, the business must meet two key requirements. First, the payroll sum requirement: the total payroll paid by the business over the five years following the transfer must be at least 400% of the average annual payroll in the five years before the transfer. This ensures that the business continues to provide employment. If the payroll sum falls short, the exemption is reduced proportionally.
Second, the administrative assets test: the ratio of administrative assets (Verwaltungsvermoegen) to total business assets must not exceed 90%. Administrative assets are non-operating assets such as securities held for investment, rental real estate not used in the business, loans to third parties, and cash or bank deposits exceeding what is needed for operating purposes. A business with more than 90% administrative assets is considered an asset-holding company rather than an operating business and does not qualify for any exemption.
The Optional Full Exemption (Optionsverschonung): 100% Tax-Free
The optional full exemption provides complete inheritance tax freedom for qualifying business assets. To qualify, the requirements are significantly stricter than for the standard exemption.
The payroll sum must be maintained at 700% of the pre-transfer average over seven years (rather than 400% over five years for the standard exemption). This means the business must maintain a substantially higher employment level over a longer period. The administrative assets must not exceed 20% of total business assets (rather than 90%). This is a much tighter limit that excludes businesses with significant non-operating holdings.
The optional exemption must be actively elected by the heir -- it does not apply automatically. This election is irrevocable, meaning that if the business subsequently fails to meet the stricter requirements, the consequences are more severe than they would have been under the standard exemption.
Small Business Simplification: 20 Employees or Fewer
For businesses with 20 employees or fewer, the payroll sum requirement is completely waived for both the standard and optional exemptions. This is an enormous simplification for small businesses, which make up the vast majority of German family enterprises.
The employee count is determined based on the average over the last five years before the transfer. Part-time employees are counted proportionally. Apprentices, employees on parental leave, and employees in their first year of employment are excluded from the count. This generous counting method means that many businesses with nominally more than 20 staff members may still qualify for the small business simplification.
What Counts as Administrative Assets
The classification of administrative assets is one of the most contentious and complex areas of German inheritance tax law. The Finanzamt scrutinizes this carefully, and disputes are common.
Cash and bank deposits are classified as administrative assets to the extent they exceed what is needed for operating purposes. The law provides no fixed percentage for what constitutes operating cash, so this is frequently a matter of professional judgment and negotiation. Securities and investment fund shares are generally administrative assets unless they serve a specific operating purpose. Rental real estate is administrative unless it is used in the core business operations. Loans to third parties are administrative unless they are trade receivables from normal business operations.
Accurate classification requires detailed analysis of the business's balance sheet and operations. Businesses preparing for succession should review their asset structure well in advance and consider restructuring to reduce administrative assets below the applicable thresholds.
Retention Period Requirements
Even after qualifying for a business asset exemption, the heir must comply with retention requirements. Under the standard exemption, the business must be continued for at least five years (Behaltensfrist). Under the optional exemption, this period extends to seven years.
If the heir sells the business, closes it, or withdraws more than the permitted amount during the retention period, the exemption is clawed back proportionally. This creates a significant ongoing obligation for heirs and requires careful planning around any business restructuring or liquidity events during the retention period.
Practical Planning for Business Succession
Business succession planning should begin years before the actual transfer. Key steps include: reviewing and restructuring the administrative asset ratio, assessing and documenting the payroll sum baseline, deciding between the standard and optional exemption based on realistic projections, considering whether a lifetime gift (with its 10-year allowance renewal) is preferable to an inheritance, and coordinating the business transfer with the overall family estate plan.
Many family businesses also benefit from establishing a family partnership (Familiengesellschaft) or converting to a legal form that facilitates gradual transfer of ownership over multiple 10-year cycles. These structures can combine business asset exemptions with personal allowance strategies to achieve highly tax-efficient succession.
Professional guidance from both a tax advisor and a lawyer specializing in succession law is essential for any significant business transfer. The stakes are high, the rules are complex, and mistakes can be extremely costly.