Investment Decisions and the Preferred Taxation of Retained Earnings After the German Income Tax Reform 2008

Abstract

This paper shows how to evaluate investment projects in transparently taxed partnerships and individual enterprises. After the German income tax reform 2008, there is an option for taxing retained earnings at a flat rate of 28.25 %‚ followed by a second taxation in the year of withdrawal. This is similar to double taxation in classical system of corporate and personal income taxes. Assuming certain expectations, the optimal alternative to any business investment is given by a capital market investment outside the business, which up from 2009 will be taxed at a flat rate of 25 %. Whether optional taxation is preferable to regular income taxation depends on the investor‘s personal income tax rate, the presumable date of withdrawal, and the capital market rate. For calculating the net present value of a project, a distinction must be made with respect to (1.) the origin of the funds (personal or firm level), the existence (2.) of a taxable income from the business and (3.) of preferably taxed earnings in the year of investment which may trigger early taxation of withdrawals.