Withholding tax: optimize your taxes

Every year, Luxembourg attracts many residents, often expatriates, who want to take advantage of its dynamic economy and attractive living conditions.

However, the Luxembourg tax system, although favorable, can seem complex to newcomers. Many people have to adapt to the specifics of taxation in two stages: withholding tax during the tax year and adjustment the following year through the annual tax return.

"This mechanism allows income tax to be deducted directly via the employer, but it does not include all income or potential tax credits and benefits. This is why the annual tax return in Luxembourg remains essential for adjusting and optimizing one's situation," confirms Séverine Bergé of Neofisc, a firm specializing in taxation.

Let's take a closer look at how this system works. What are the tax obligations and ways to reduce your tax bill through tax credits and deductions in Luxembourg?

Understanding withholding tax to better manage your taxes

Withholding tax: how does it work in Luxembourg?

Luxembourg applies a tax system based on withholding tax. This system, which applies to both residents and non-residents, allows the state to collect tax directly from salaries via the employer. The employer acts as an intermediary between the taxpayer and the tax authorities.

Understanding the criteria for this withholding tax and changes in its rate can be complex for expatriates and new arrivals. The amount withheld by the employer is determined by factors such as income level and family situation, making tax calculations unpredictable.

Two main criteria influence this withholding tax:

• Income: Luxembourg uses a progressive tax scale with rates ranging from 0% to over 42%. This rate is calculated based on annual taxable income. It increases proportionally with income.
• Family situation: a specific rate is applied according to the taxpayer's marital status (single, married, single parent, etc.), allowing for adjustments based on family responsibilities.

Advice from our Neofisc tax expert on withholding tax

"The information on the withholding form must be verified, as it determines the rate applied. In the event of an error or a change in circumstances (marriage, birth, etc.), it is essential to update your withholding form to avoid paying an incorrect amount."

Tax classes: which one are you in and how can you benefit from it?

What are the tax classes in Luxembourg?

Luxembourg taxpayers are classified according to their marital status into three main tax classes:

• Class 1 for single people, civil partners without children, and non-resident married couples;
• Class 1A for single-parent families or civil partners with children;
• Class 2 for resident married couples.

Married non-residents may opt out of class 1 and request the application of an average rate.

Newcomers and expatriates often encounter difficulties with their tax class. This is particularly the case for couples who are cohabiting or in a civil partnership and are classified in class 1. This also applies to temporary residents. The tax class influences the tax rate and therefore the amount deducted each month.

Updating your tax bracket after a change in circumstances

Your tax bracket has a direct impact on your deductions. An adjustment is necessary as soon as there is a change in your marital status: marriage, divorce, birth of a child, or change of country of residence (from Luxembourg to a neighboring country).

Non-residents must inform the authorities in order to update their tax class when there is a change in marital status or the birth of a child. After completing the necessary steps, you must check that your new withholding slip reflects your situation.

For Luxembourg residents, the update is automatic. However, it is still recommended that you check to ensure that your tax is correct.

See the impact of your type of union (cohabitation, civil partnership, or marriage) on your taxation in Luxembourg.

Tax returns: how to optimize your taxes?

Annual tax return: an essential step in adjusting your tax

Withholding tax is provisional and represents an initial estimate of the tax due on your income. However, it does not include variable or additional income. This situation often leads to significant differences between the tax withheld and the tax actually due, requiring a tax return to adjust the final amount.

Variable income (e.g., bonuses), changes of employer or status during the year (illness, job loss, maternity or parental leave) can significantly affect the amount of tax payable. Self-employed individuals or people with sources of income other than salary are also affected, as withholding tax is not always applied.

The tax return in Luxembourg, filed the following year, allows these discrepancies to be corrected. It takes into account all income and expenses, allowing for an accurate calculation of the actual tax due. This is then compared to the amounts withheld by the employer. It is then possible to obtain a refund of any overpayment if the deductions were too high, or to pay a supplement if the opposite is true.

Advice from our Neofisc expert

Even if it is not mandatory for everyone, filing a tax return is strongly recommended in order to verify the accuracy of your taxation and the possibility of obtaining a refund. It is also a way of identifying the tax benefits available to reduce your tax burden.

Are you required to file a tax return?

In Luxembourg, there are several situations in which filing a tax return is mandatory. Exceeding certain income thresholds, as well as certain family situations, require you to file a return.

Failure to comply with filing obligations can result in significant penalties and a retroactive adjustment covering five years. This is particularly the case for those with foreign income, annual income exceeding €100,000, or married couples who are residents and non-residents and have opted for joint taxation.

The main cases requiring annual tax returns are as follows:

• Annual taxable income exceeding €100,000;
• Married couples taxed collectively;
• Civil union couples (partnership contract) wishing to benefit from joint taxation;
• When combining several sources of income (salaries, pensions, rental income, capital gains, etc.) whose total amount exceeds certain thresholds;
• In the case of income that has not been subject to withholding tax (e.g., rental income).

What does our expert recommend?

It is essential to file your tax return before December 31 of the year following the tax year ( e.g., before December 31, 2024, for 2023 income). This will allow you to avoid a fine (between €400 and €500) and the loss of any potential tax refund.

Plan ahead to prepare your tax return so you don't miss the deadline. Don't wait until December to gather all the information you need for your return.

Reduce your tax bill: the best tax optimization strategies

Tax credits and deductions you shouldn't miss

Luxembourg offers various measures to reduce the tax burden on taxpayers, in the form of a reduction in taxable income for all taxpayers. There is also a tax credit for single-parent families. These are powerful tools for reducing your tax bill, but they are sometimes overlooked or underused.

Due to a lack of information or simply forgetting, some taxpayers do not take advantage of all the deductions to which they are entitled or do not check the relevant boxes on their tax returns, thereby losing out on significant amounts of money.

The main tax benefits for reducing your tax bill include:

• Single-parent tax credit: up to €2,500, reserved for single-parent families;
• Higher deductions for families with children;
• Deductions for certain expenses related to individuals, particularly children;
• Deductions for housing costs, to encourage the purchase of a primary residence in a rapidly rising real estate market.

Why use a tax advisor?

After a thorough analysis of your situation, a tax advisor will be able to identify all the tax deductions to which you are entitled in Luxembourg. An oversight or error in a box can represent a loss of several thousand euros.

This applies in particular to families with dependent children, single-parent families, or blended families with shared custody arrangements.

People with foreign income or multiple categories of income are also affected. Determining taxable income requires specific tax adjustments for each category of income, often with several possible alternatives.

Investments and savings: options to reduce your tax burden

Luxembourg residents and non-residents have access to savings options with tax incentives. These schemes enable taxpayers to secure their financial future while reducing their income tax.

Without a savings strategy, Luxembourg taxpayers often pay more tax than necessary. However, investing in eligible products can lead to significant savings on the taxable amount.

Here are some investment products to consider in order to reduce your tax bill:

• Pension savings (111 bis): encourages savers to build up capital for their retirement in addition to the general pension scheme, thereby reducing their tax burden.
• Home savings: allows you to save to finance the purchase of your main residence and obtain a preferential rate on part of the loan. It can also finance the purchase of any real estate, but deductibility is only possible under certain conditions.

What does our Neofisc expertsay about investment strategies for reducing your tax bill?

To maximize tax reductions, establish a long-term investment strategy in pension savings and home savings. The support of an advisor allows you to evaluate the most profitable options according to your personal and professional goals.

Our recommendations for optimizing your taxes in Luxembourg

In conclusion, the withholding tax system in Luxembourg may seem simple at first glance. However, a thorough understanding is necessary to optimize it and avoid mistakes.

Although the monthly withholding by the employer is an estimate, only the annual tax return allows for an accurate calculation of the tax due. Thanks to this return, taxpayers can benefit from tax credits and deductions that will significantly reduce their tax burden. Finally, investment strategies, such as pension savings or real estate investment, complement these measures by offering long-term solutions.

Given the complexity of the tax system, it is advisable to consult a tax expert to take advantage of every opportunity for optimization. Firms specializing in tax advice, such as Neofisc, can help you develop tailor-made tax strategies, thereby maximizing the benefits offered by the Luxembourg system.

By investing in the services of a tax expert, the return on investment is almost always guaranteed. The tax savings often more than cover the consultation fees. For many taxpayers, this expert support not only optimizes every euro of tax, but also secures their tax situation with complete peace of mind.

Calculation of actual taxation in Luxembourg with and without optimization

Let's take the example of X and Y, a married couple with no children, both under the age of 40.

• X's annual taxable income: €20,000
• Y's annual taxable income: €80,000

Actual tax without optimization: €15,369

Tax with optimization (*): €13,948

This represents a tax reduction of €1,421 while also generating savings.

(*) Based on pension savings and home savings.