Avoid double income taxation in Germany: A guide for US expats

Want to understand how income taxes work for US citizens in Germany and learn about strategies to avoid double taxation? Melissa Groves, a tax specialist for Bright!Tax, has all the answers you need. 

It’s no wonder Germany is a popular destination for US expats: the 120.000+ Americans currently living there appreciate the strong German economy with plenty of employment opportunities, great healthcare and education systems, and, in general, high quality of life.

If you’re planning to set sail for Germany or have just landed there, there might be one “technicality” left to figure out: your taxes. Whether you’re generating income sourced in Germany or worldwide, as a US citizen, you’re also subject to US taxes.

But how can you avoid paying taxes on the same income twice? This guide will help you understand the strategies you have at your disposal.

What taxes do US citizens pay in Germany?

Tax residency for US citizens in Germany is determined based on the duration and purpose of their stay.

Generally, individuals who reside in Germany for more than 183 days in a calendar year are considered tax residents. Individuals with a permanent home or habitual abode in Germany are also considered tax residents, regardless of the duration of their stay.

The general rule for US expats living in Germany is the following:

• Residents pay German taxes on all their income (both German-sourced and worldwide).
• Non-residents only pay German taxes on their German-sourced income.

Other than income taxes, as an American citizen living in Germany, you may need to pay self-employment tax (if you start your own business there), capital gains tax, taxes on rental income, and more.

But, if you still have dual citizenship (you haven’t renounced your US passport), you’re also still subject to US income taxes, no matter how much time you spend in Germany. The next section will walk you through strategies that will help you optimize your taxes and avoid double taxation on your income.

Strategies to avoid double taxation as a US expat in Germany

You may have heard of tax treaties - agreements between countries that should, in theory, prevent double taxation. Germany has a tax treaty with the US, but - confusingly - this document contains a clause that essentially eliminates the benefits of the treaty.

Luckily, however, there are a number of other strategies that US expats can use:

1. Foreign Tax Credit (FTC)

The foreign tax credit is a provision in the US tax code designed to prevent double taxation for taxpayers who earn income abroad and pay taxes on that income to a foreign government. It allows individuals to offset their US tax liability by the amount of foreign taxes paid on the same income, ensuring that they are not taxed twice.

To claim the foreign tax credit, you must meet certain criteria, such as being a US citizen or resident alien and having foreign tax liability on income that is subject to US tax.

Your first step is to collect documentation of foreign taxes paid, such as tax forms, receipts, and statements from foreign tax authorities. Then, use IRS Form 1116 to calculate and claim the foreign tax credit. This form requires detailed information about your foreign income, taxes paid, and the calculation of the credit.

2. Foreign Earned Income Exclusion (FEIE)

The Foreign Earned Income Exclusion is another provision in the US tax code that allows taxpayers to exclude a certain amount of their foreign earned income from US taxation. It’s designed to provide relief for US citizens and resident aliens who live and work abroad, allowing them to avoid double taxation on their foreign income.

To qualify for the foreign earned income exclusion, you must meet one of two tests: the Bona Fide Residence Test or the Physical Presence Test.

Under the Bona Fide Residence Test, taxpayers must be bona fide residents of a foreign country for an uninterrupted period that includes an entire tax year. The Physical Presence Test requires taxpayers to be physically present in a foreign country for at least 330 full days during any consecutive 365-day period.

Use Form 2555 to claim the foreign earned income exclusion on your US tax return. This form requires detailed information about your foreign earned income, residency status, and qualification for the exclusion.

3. Totalization Agreements

The US-Germany Totalization Agreement is a bilateral agreement between the United States and Germany designed to coordinate the social security systems of both countries and eliminate dual social security taxation for individuals who work and earn income in both countries.

Under this agreement, US expats living and working in Germany may be exempt from paying US social security taxes on their income earned in Germany, if they are covered by the German social security system.

In simple words, by leveraging the Totalization Agreement, you avoid paying into both social security systems simultaneously, which means you avoid double taxation on your social security contributions.

Bonus: Child Tax Credits

One final note: US expats with kids can also claim the Child Tax Credit just as they would in the US, for a partial refund, typically worth up to $1.500 per qualifying child.

Need help navigating taxes for US expats in Germany? Bright!Tax specializes in working with US expats to ensure tax compliance and filing confidence no matter where they live outside the US. Book a free kickoff call with their experts today!