Iceland operates a progressive tax system where income tax rates increase with higher earnings. Both employers and employees have distinct tax obligations and contributions that must be managed correctly. Employers are responsible for withholding income tax from employee salaries and paying social security contributions, while employees benefit from personal tax credits and may be eligible for certain deductions. Navigating these requirements is essential for compliant employment in Iceland.
Understanding the specific tax rates, thresholds, and reporting procedures for 2025 is crucial for businesses employing staff in Iceland. This includes adhering to monthly payroll reporting obligations and annual declarations to the Icelandic tax authorities.
Employer Social Security and Payroll Tax Obligations
Employers in Iceland are required to pay social security contributions on the gross salaries of their employees. These contributions fund various social programs. The primary contribution is the employer's social security tax (tryggingagjald).
For 2025, the general rate for the employer's social security tax is expected to be 6.90% of the total gross remuneration paid to employees. This rate applies to most sectors.
There may be a reduced rate for specific sectors, such as fishing and agriculture, which is expected to be 0.34% for 2025.
These contributions are calculated on the total amount of wages, salaries, and other taxable benefits paid to employees before any deductions. Employers are responsible for calculating, reporting, and paying these contributions monthly to the Directorate of Internal Revenue (Skatturinn).
Income Tax Withholding Requirements
Employers are obligated to withhold income tax (PAYE - Pay As You Earn) from employee salaries on behalf of the tax authorities. The amount of tax to be withheld depends on the employee's income level and their personal tax credit.
Iceland has a progressive income tax system with different tax brackets. The tax rates and brackets for 2025 are expected to be structured as follows:
| Annual Income (ISK) | Tax Rate |
|---|---|
| Up to 447,897 per month | 31.45% |
| Above 447,897 per month | 37.95% |
Note: These brackets and rates are based on current legislation and projections for 2025 and are subject to final confirmation.
Employees are entitled to a personal tax credit, which reduces the amount of income tax they owe. For 2025, the full personal tax credit is expected to be 69,288 ISK per month. Employees can choose to have their full personal tax credit applied to their main employment income or distributed among multiple employers. If the full credit is not utilized against income tax, the remainder can be used against municipal taxes.
Employers must calculate the correct amount of income tax to withhold each pay period based on the employee's gross pay and their allocated personal tax credit.
Employee Tax Deductions and Allowances
Employees in Iceland benefit primarily from the personal tax credit. While the tax system is designed with limited deductions compared to some other countries, certain contributions and expenses can reduce an employee's taxable income or tax liability.
Key deductions and allowances for employees include:
- Personal Tax Credit: As mentioned, this is the primary allowance reducing income tax liability.
- Mandatory Pension Contributions: Employees are required to contribute a percentage of their salary to a pension fund. The mandatory employee contribution is 4% of gross salary. These contributions are deductible from the employee's taxable income. Employers also make contributions on behalf of the employee (typically 8% or more, depending on the collective agreement), which are not considered employee income but an employer cost.
- Voluntary Pension Savings: Employees can make additional voluntary contributions to a private pension scheme (third pillar). These contributions, up to a certain limit (currently 4% of gross salary, matched by the employer up to 4%), are also tax-deductible.
- Child Benefits: Families may be eligible for child benefits, which are paid directly to the parent and are not a deduction from income tax but rather a social benefit. Eligibility and amounts depend on income and the number of children.
- Interest Expenses: Under certain conditions, interest paid on housing loans may be partially deductible.
Employees typically do not need to claim these standard deductions (like pension contributions) explicitly; they are usually accounted for in the payroll calculation. Other deductions or allowances might require specific reporting by the employee in their annual tax return.
Tax Compliance and Reporting Deadlines
Employers in Iceland must adhere to strict monthly and annual reporting requirements.
- Monthly Reporting (PAYE): Employers must file a monthly wage report (skilagreining) detailing the gross salaries paid, tax withheld, and social security contributions for each employee. This report and the corresponding payments are due by the 15th of the month following the payroll period. For example, payroll for January is reported and paid by February 15th.
- Annual Reporting: Employers must submit an annual summary of wages paid and taxes withheld for all employees. This report is typically due early in the year following the tax year (e.g., January or February 2026 for the 2025 tax year).
- Employee Annual Tax Return: Employees must file their personal income tax return annually. The deadline for filing is typically in March of the year following the income year (e.g., March 2026 for the 2025 tax year). Employers provide employees with a summary of their annual earnings and tax withheld to assist with this filing.
Failure to meet these deadlines can result in penalties and interest charges.
Special Tax Considerations for Foreign Workers and Companies
Foreign individuals working in Iceland and foreign companies employing staff there may face specific tax considerations.
- Tax Residency: An individual is generally considered a tax resident in Iceland if they stay in the country for more than 183 days within a 12-month period. Residents are taxed on their worldwide income, while non-residents are generally only taxed on income sourced in Iceland.
- Foreign Workers: Foreign workers who become tax residents are subject to the same income tax rules, including the personal tax credit, as Icelandic citizens. Non-resident workers earning income in Iceland are subject to income tax withholding on their Icelandic-sourced income, but may not be eligible for the full personal tax credit unless specified by a double taxation treaty.
- Foreign Companies: A foreign company employing staff in Iceland may establish a taxable presence (Permanent Establishment) depending on the nature and duration of its activities. If a Permanent Establishment is created, the company becomes subject to Icelandic corporate tax on the profits attributable to that establishment. Even without a Permanent Establishment, a foreign company employing staff in Iceland is generally required to register as an employer and fulfill the employer obligations regarding PAYE withholding and social security contributions.
- Double Taxation Treaties: Iceland has double taxation treaties with numerous countries. These treaties can affect where income is taxed and may provide relief from double taxation for individuals and companies with tax liabilities in both Iceland and another treaty country. The provisions of the relevant treaty should be consulted.
Navigating these international aspects often requires careful consideration of residency rules, treaty provisions, and registration requirements with Icelandic authorities.
