Withholding tax: optimize your taxes

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

However, the Luxembourg tax system, while favorable, can seem complex to newcomers. Indeed, many must adapt to the specifics of two-stage taxation: withholding tax during the tax year and an adjustment the following year through the annual tax return.

Understanding Withholding Tax to Better Manage Your Taxes

"This mechanism allows income tax to be withheld directly through the employer, but it does not include all income or potential tax credits and benefits. That is why the annual tax return in Luxembourg remains essential for adjusting and optimizing one’s tax situation."

- 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 how can you reduce your tax liability through tax credits and deductions in Luxembourg?

Withholding tax: how does it work in Luxembourg?

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

Understanding the criteria for this withholding tax and how its rate changes can be complex for expats and newcomers. The amount withheld by the employer is determined by factors such as income level and family status, making the tax calculation 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 and increases proportionally with income.
• Family status: A specific rate is applied based on the taxpayer’s marital status (single, married, single-parent family, etc.), allowing for adjustments according to family responsibilities.

Advice from our Neofisc tax expert on withholding tax

"The information on your 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 brackets: Which one applies to you, and how can you benefit from it?

What are tax classes in Luxembourg?

Luxembourg taxpayers are classified into three main tax classes based on their marital status:

• Class 1 for single people, civil union partners without children, and married non-residents;
• Class 1A for single-parent families or civil union partners with children;
• Class 2 for married resident couples. - See the impact of the type of union and the upcoming tax reform

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 living in a common-law relationship or under a civil partnership agreement, who are classified in Class 1. This also applies to temporary residents. The tax class influences the tax rate and therefore the amount withheld each month.

Updating Your Tax Class After a Change in Circumstances

Your tax bracket directly affects your tax withholdings. An adjustment is required whenever there is a change in your civil status: marriage, divorce, the birth of a child, or a change in country of residence (from Luxembourg to a neighboring country).

For non-residents, you must notify the tax authorities to update your tax class in the event of a change in civil status or the birth of a child. After completing the necessary steps, you must verify that your new withholding form reflects your current situation.

For Luxembourg residents, the update is automatic. However, a check is still recommended to ensure correct taxation.

Note: Tax class 2 will be phased out in 2028, to be replaced by a single tax class. See how your relationship status (cohabitation, civil partnership, or marriage) affects your taxes in Luxembourg.

Tax return: how to optimize your taxes?

Annual tax return: an essential step to adjust your tax liability

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

Variable income (e.g., bonuses), changes in employer or status during the year (illness, job loss, maternity or parental leave) can significantly affect the amount of taxes owed.

Self-employed individuals or those with sources of income other than wages are also affected, as withholding tax is not always applied.

The tax return in Luxembourg, filed the following year, allows you to correct these discrepancies. It takes into account all income and expenses, enabling an accurate calculation of the actual tax liability. This amount will be compared to the amounts withheld by the employer. You may then be eligible for a refund of overpaid taxes if the withholdings were too high, or you may owe additional taxes if the opposite is true.

Advice from our Neofisc expert

Even though it is not mandatory for everyone, filing a tax return is strongly recommended to verify the accuracy of your tax assessment and to determine if you are eligible for a refund. It is also a way to identify available tax benefits that can help reduce your tax burden.

Are you required to file a tax return?

In Luxembourg, several situations make filing a tax return mandatory. Exceeding certain income thresholds, as well as certain family situations, require you to file this return.

Failure to comply with filing obligations can result in significant penalties and a retroactive tax assessment covering the past five years. This applies in particular to those with income from foreign sources, an annual income exceeding €100,000, or married couples—both residents and non-residents—who have opted for joint taxation.

Here are the main cases requiring an annual tax return:

• Annual taxable income exceeding €100,000;
• Married couples taxed jointly;
• Couples in a civil partnership (PACS) wishing to be taxed jointly;
• When there is a combination of multiple income sources (salaries, pensions, rental income, investment income, etc.) whose total amount exceeds certain thresholds;
• In the presence 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 by December 31 of the year following the tax year (e .g. , by 12/31/2024 for 2023 income). This will help you avoid a fine (between €400 and €500) and the loss of any potential tax refund.

Start preparing your tax return early to avoid missing the deadline. Don’t wait until December to gather all the necessary documents for your return.

Reduce Your Taxes: 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 reductions 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 underutilized.

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

The main tax benefits to reduce your tax liability include:

• Single-Parent Tax Credit: up to €2,500, reserved for single-parent families;
• Higher deductions when you have children;
• Deductions for certain personal expenses, particularly thoserelated to children;
• Deductions for housing costs, to encourage the purchase of a primary residence in a rapidly rising real estate market.

Why consult a tax advisor?

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

This applies in particular to families with dependent children, single-parent families, or blended families where children are in joint custody.

Individuals with income from foreign sources or multiple categories of income are also affected. Indeed, determining taxable income requires specific tax adjustments for each category of income, and often involves various possible alternatives.

Investments and Savings: Options to Reduce Your Tax Burden

Luxembourg residents and non-residents have access to tax-advantaged savings options. These schemes allow taxpayers to both secure their financial future and reduce their income tax.

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

Here are some investment products to consider to reduce your tax liability:

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

What does our Neofisc expertsay about investment strategies to reduce your taxes?

To maximize tax savings, establish a long-term investment strategy involving pension savings and home savings plans. Working with an advisor allows you to evaluate the most profitable options based on your personal and professional goals.

Our recommendations for optimizing your taxes in Luxembourg

In conclusion, Luxembourg’s withholding tax system 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 owed. Through this return, taxpayers can benefit from tax credits and deductions that will significantly reduce their tax burden. Finally, investment strategies, such as retirement savings or real estate investments, complement these measures by offering long-term solutions.

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

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

Calculation of actual tax liability in Luxembourg with and without optimization

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

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

Actual tax without optimization: €15,369

Tax with optimization (*): €13,948

That’s a tax reduction of 1,421 euros while still building savings.

(*) Based on pension savings and home savings.