TAXATION AND U.S. CITIZENS IN GERMANY
by Dagmar Gessner Gaspar
and Michael Koehler, KPMG, Frankfurt
A U.S. citizen who establishes residency in Germany will be taxed by Germany
on his or her worldwide income. Germany will tax the expatriate’s
compensation and most types of investment income even if earned outside
Germany. As a U.S. citizen, the expatriate is also liable for tax on his
or her worldwide income in the U.S. under the provisions of the U.S.
Internal Revenue Code (IRC).
to the IRC, relief from double taxation through the foreign tax credit
rules is granted only with respect to income from sources outside the U.S.
Absent special provisions of a treaty, generally no foreign tax credit is
available on U.S.-source
income taxed by a foreign country. Germany, on the other hand, will not
allow an exemption from tax or a credit for foreign taxes incurred on
income for which the primary right of taxation has been given to Germany
as the country of residence under an income tax treaty.
Consequently, Germany will not allow a credit for
U.S. taxes incurred by a U.S. citizen on U.S.-source income if, under the
U.S.-Germany income tax treaty, the primary right of taxation has been
given to Germany as the country of residence. At the same time, the
foreign tax credit rules of the IRC limit the ability to utilize a credit
for German taxes incurred on such U.S.-source income.
for Avoiding Double Taxation
Several mechanisms exist for avoiding the double
taxation described above, the main one being the re-sourcing provisions
under Article 23 (3) of the U.S.-Germany income tax treaty. Pursuant to
Article 23 (3) of the U.S.-Germany income tax treaty, the U.S. will treat
U.S.-source income earned by a U.S. citizen residing in Germany as though
it was derived from German sources. Consequently, the U.S. will allow a
foreign tax credit for such income to the extent that
German tax is actually imposed on such income in accordance with the
Relief May or May Not Be in Sight
Below are several examples of when Germany will
tax U.S.-source income without relief or limited relief for U.S. tax
incurred on such income by a U.S. citizen.
- One of the most common situations involves U.S. assignees who reside in Germany
and take business trips to the U.S. during their international assignment in
Germany. The compensation allocable to the U.S. workdays is considered U.S.-source income under the IRC since the services
were performed in the U.S. On the other hand, this compensation will be
subject to undiminished German taxation under Article 15 of the U.S.-Germany
income tax treaty if the expatriate is present in the U.S. for less than 183
days during the calendar year and the compensation is borne by a German
entity or permanent establishment of a U.S. entity in Germany. To avoid the
double taxation of such wages, the compensation allocable to U.S. workdays
will be treated as foreign-source income on the U.S. return under Article 23
(3) of the U.S.-Germany treaty. It is important to note that the income is
treated as foreign source for foreign tax credit purposes only and will not
qualify for the foreign earned income exclusion under IRC Section 911.
- Investment income is another category of income for which Germany, as the country of
residence, will grant no or only limited relief for U.S. taxes incurred.
Investment income includes interest income, dividend income, and capital gains distributions from certain mutual
funds. Germany will tax investment income of a German resident to the extent
it exceeds DM 3,100, for single taxpayers and DM 6,200, for married
taxpayers filing jointly (DM 6,100, and DM 12,200, respectively for years
prior to 2000) – hereinafter referred to as exclusion amount. [DM 1 = USD
- Under Article 11 of the U.S.-Germany treaty, the U.S. is not allowed to impose any
tax on U.S.-source interest earned by a German resident, and Germany will
not grant any relief for U.S. tax imposed on U.S.-source interest income
earned by a U.S. citizen residing in Germany. Therefore, U.S.-source
interest income in excess of the pro-rata share of the exclusion amount must
be treated as foreign source income on the U.S. return.
- The U.S. may impose a tax of 15 percent on U.S.-source dividends earned by a
German resident under Article 10 of the U.S.-Germany treaty. Germany will
therefore grant a credit for U.S. tax imposed on U.S.-source dividends up to
15 percent of the U.S.-source dividends subject to German tax. To the extent
that the effective U.S. tax rate of the expatriate exceeds 15 percent, a
portion of the U.S.-source dividend exceeding the pro-rata share of the
exclusion amount must be partially treated as foreign source on the U.S.
return to limit the U.S. tax imposed to 15 percent of the dividend taxable
- Germany treats capital gains distributions from mutual funds not registered in
Germany as dividend income. A credit for U.S. tax under Article 10 of the
U.S.-Germany treaty is not possible, since the U.S. treats such
distributions as capital gains income and would not impose the 15 percent
withholding tax if the distributions were earned by a person other than a
U.S. citizen. However, the U.S. will consider capital gains from the
disposition of personal property as foreign source income under IRC Section
865 if the foreign tax imposed thereon is at least 10 percent. Consequently,
capital gains from mutual funds not registered in Germany are treated as
foreign source on the U.S. return under IRC Section 865 if the German tax
imposed thereon (computed considering the pro-rata share of the exclusion
amount) is 10 percent or more of the gain recognized.
- Under Article 19 of the U.S.-Germany treaty, U.S. social security benefits may be
taxed only by the country of residence. The saving clause otherwise
applicable to U.S. citizens does not apply to social security benefits
pursuant to Article 1 of the Protocol of the U.S.-Germany treaty. Therefore,
U.S. social security benefits received by a U.S. citizen residing in Germany
are completely exempt from U.S. tax.
- Pensions other than social security benefits or U.S. government pensions may
also be taxed only by the country of residence under Article 18 of the U.S.-Germany
income tax treaty. However, the extent to which a pension is taxed by Germany may
differ from the extent to which it is taxed by the U.S. Re-sourcing pursuant to
Article 23 (3) of the U.S.-Germany income tax treaty is limited to the portion
of the pension taxed by Germany under its national tax provisions.
Relief Is Possible, but Coordinate Return Preparation
As can be seen from the examples above, relief
from double taxation for U.S. citizens residing in Germany must be claimed
on the U.S. return in many cases. In addition, relief will only be granted
on the U.S. return under Article 23 (3) of the U.S.-Germany treaty to the
extent that German tax is actually imposed on U.S.-source income. Therefore,
it is important to closely coordinate the preparation of the U.S. and the
German returns to determine to what degree Germany will actually impose tax
on U.S.-source income. Relief, therefore, should be claimed on the U.S.
return; if not, the income of U.S. citizens residing in Germany will be
subject to double taxation.