Karlsruhe will decide – will inheritance tax be reformed?

Landmark judgment expected from Federal Constitutional Court 

After years of relative calm, inheritance tax is once again being scrutinised under constitutional law in Germany. Several proceedings pending before the Federal Constitutional Court in Karlsruhe could once again fundamentally change the German Inheritance and Gift Tax Act ("ErbStG"). 

Of central importance here is case 1 BvR 804/22, in which the constitutionality of tax benefits for the transfer of business assets is expected to be assessed in 2025. The point of contention is whether the current tax exemption system for business assets (sections 13a-13c, 28a ErbStG) - which provides for extensive preferential tax treatment - is compatible with the principle of equality (Article 3 Basic Law). One criticism is that business assets are often transferred virtually tax-free, while private assets are subject to significant taxation. If the court finds this to be a violation of the constitution, it could have far-reaching consequences for the current inheritance tax privileges for business assets. 

Other proceedings are also pending that could provide additional impetus, albeit with less impact. Case 1 BvR 1381/24 concerns the so-called Jastrow clause in Berliner testaments (Jastrowsche Klausel im Berliner Testament) and the possible double taxation of so-called delayed legacies (betagte Vermächtnisse). Case 1 BvR 1761/24 (the "car park case"/"Parkhaus-Urteil") concerns the distinction between exempt business assets and not-exempt administrative assets in relation to real estate. Ultimately, the Bavarian state government initiated an abstract judicial review of the law in case 1 BvF 1/23, which aims at a comprehensive reform of inheritance tax with proposals for higher tax allowances, regionalised tax rates and greater support for families. 

Consequences if the Inheritance and Gift Tax Act is found to be unconstitutional 

The judgment on preferential treatment of business assets is expected shortly. In previous decisions on the unconstitutionality of the Inheritance and Gift Tax Act the court allowed the law to continue to apply for a short transitional period while the legislator had to create a new regulation in line with the constitution. A similar approach can also be expected in the current proceedings. 

Increasing political pressure for reform 

An amendment to the Inheritance and Gift Tax Act is also to be expected in view of political reform proposals. Meanwhile, the political debate on reform is gaining momentum alongside the court proceedings. The upcoming judgment on the preferential treatment of business assets is likely to be the decisive impetus for a reorganisation of inheritance tax. 

In addition to adjusting of the tax allowances , a comprehensive reform of inheritance tax, for example by introducing a (low) flat tax, and abolishing privileges are under political discussion. In particular, certain tax advantages which are used especially for large business assets are being criticised: 

• Tax Waiver model for large acquisitions (Erlass-Modell für Großerwerbe): For large acquisitions in particular (acquisitions of tax-privileged assets of more than EUR 26 million per acquirer), it is possible to obtain a full tax waiver under certain conditions. In many cases, business owners make use of this by transferring the company to a family foundation managed by the business owner or by the next generation. 
• Tax-privileges for housing companies (Wohnungsunternehmen): On the basis of current law, companies with extensive property holdings (so-called Wohnungsunternehmen) can be transferred on a tax-privileged basis. 

Both regulations could be restricted considerably or completely abolished with a reform. 

In its latest annual report, the German Council of Economic Experts also called for inheritance tax reform. The highly preferential treatment of business assets should be reduced and the ability-to-pay principle strengthened. For assets of less than EUR 26 million, the tax exemption is to be reduced, while for larger assets the so called "Verschonungsbedarfsprüfung" (needs test) should no longer apply or be significantly restricted. They recommend generous deferred payments to avoid an excessive liquidity burden on companies. They also propose a standardised lifetime allowance. 

Significance of the expected German Federal Constitutional Court rulings for owner-operated companies 

If the preferential treatment for business assets is deemed to be unconstitutional - even only partially - the current system of tax relief for business transfers will probably no longer apply to the transfer of larger business assets, in particular following an amendment to the law. In view of the current political debate, and in particular the report from the German Council of Economic Experts, the current scope of the tax advantages is no longer tenable. Business owners may therefore only have little time left to transfer companies with tax-privileged treatment. 

The implementation of the company transfer must be carefully planned and therefore regularly requires a long lead time. For example, restructuring is often necessary before a transfer in order to optimise the tax advantages. In addition, the transfer of the company must find consensus within the family. All family members should therefore be involved in the process to minimise the risk of disputes within the family. 

Recommendations for action - especially for owner-operated companies 

In particular for business owners who are planning to transfer their company in the medium term, it is advisable to analyse the current situation at an early stage to be able to act in the event of an imminent change in the law and not have to act hastily. Timely preparation makes it possible to utilise structuring before options changes in the law occur.