Why US expats in Germany don’t have a tax problem… they have a paperwork problem

US expats are concerned about double taxation. But here’s the thing: for most expats, double taxation isn’t the biggest problem. The biggest headache for Americans in Germany isn’t tax; it’s paperwork. Or, more specifically: U.S. reporting requirements. Those endless forms…and the penalties you pay if you don’t file them correctly.

You will (most likely) not pay tax twice

The good news is that the US does a pretty good job of minimizing double taxation with the Foreign Earned Income Exclusion (FEIE) and foreign tax credit (FTC). And since German income taxes are generally higher than the US taxes, most Americans don’t pay any additional US tax on salary earned in Germany.

OK, so if double taxation is not the issue, then what is the problem? The problem is filing your taxes. Or, more succinctly, the US reporting requirements. Even if you owe the US zero in taxes as an expat, you may still be required to file several forms each year.

And each form has its own rules, its own thresholds, and its own penalties. Before you know it, you’re drowning in paperwork! 

Get help with all that paperwork now

Foreign bank accounts

Naturally, you probably have non-US bank accounts because you live outside the United States. Maybe also a checking account. A savings account. Perhaps an investment account or two. But all these bank accounts in Germany are to be reported to the IRS.

If you pass one of their thresholds (more on that later), you’ll be required to file an FBAR. Depending on your situation, you may also need to file Form 8938 under FATCA. You won’t necessarily owe more tax because of these forms. But if you don’t file them, you could be facing some pretty sizable penalties. 

Investments

US reporting requirements start to get even trickier when you hold investments. You may own things that are considered perfectly normal here in Germany: Mutual funds, ETFs, stocks, and bonds. But to the IRS, those mutual funds might be considered Passive Foreign Investment Companies (PFICs). Holding PFICs triggers two problems:

• Annual reporting requirements
• Less-than-friendly tax treatment 

That perfectly normal investment account back home suddenly requires hours of additional paperwork and more accounting fees! And if you think that’s bad, get ready for the next part…

Ownership in a company? Form 5471 is waiting! 

Owning interests in foreign corporations is where US reporting requirements start to get crazy. If you own more than certain thresholds in foreign corporations, you might even be taxed by the US government on income you’ve never actually received. That’s because the US has rules called CFC reporting. If you’re ever called to file Form 5471, you’ll know you’ve entered Beast Mode when it comes to your US taxes.

Ownership in a company = Reporting requirements to the IRS 

So, what is Form 5471? Well, Form 5471 is used to report information about certain foreign corporations. Form 5471 itself is not actually attached to your personal tax return. Form 5471 is filed as its own corporate return. Basically, this means that if you own a foreign company as a US person, you have to file extra paperwork.

Rules for Controlled Foreign Corporations 

Let’s say you own 100% of a foreign corporation. Congratulations, that company may be considered a Controlled Foreign Corporation, or CFC. A Controlled Foreign Corporation is a corporation that is taxed under US special taxation rules if more than 50% of the corporation is owned by US shareholders. Since Germany taxes corporate profits at the corporate level, most US expats don’t worry about this until…

Profits are repatriated 

You (or another US shareholder) withdraw funds from the company. That’s when some of the CFC rules kick in, and you’re taxed on income you never actually received. 

The “cost” of US taxes

Do you have extra bank accounts? That’s extra forms. Do you hold investments? Even more forms. Do you own a foreign company? Congratulations, you get to maximize your IRS lovefest by… filing extra forms. And each additional form means more accounting fees.

It’s not uncommon for Americans with relatively simple financial lives in Germany to pay thousands of dollars each year in accounting fees just to file their US taxes. The real cost of being a US taxpayer isn’t the taxes you pay. It’s keeping up with the reporting requirements. 

Penalties

And let’s not forget about penalties. Yeah… You don’t realize you have to file an FBAR? The penalty is $10.000 per violation. And each account you didn’t report is considered a separate violation. You don’t file Form 5471 when you’re supposed to file? You can be assessed a penalty equal to $25.000, plus 35% of the net income of the corporation. 

Knowledge is key

Keeping your obligations straight can be daunting. Especially if you’re not lucky enough to work with a tax professional who specializes in these issues. The best way to manage your US tax reporting obligations is to learn about them, BEFORE you incur them.

Thinking about buying that investment account in Germany? Want to open up a business? Before you do anything, ask yourself: “What do I have to report to the US about this?” Tax consequences should be part of your decision-making process. 

However, they also shouldn’t drive it. Don’t live in fear of being taxed twice. Instead, focus on what you need to report twice.