Tax discrimination against US citizens in Germany?

US citizens often complain that they are discriminated against in terms of taxation when they come to Germany and take up residence there. In some cases, Germany is then accused of double taxation as the country of residence. The argument is: “The income has already been taxed in the US.” This argument fails to recognize the real reasons for what is sometimes indeed double taxation.

The real reason is that the US taxes its citizens even if they are not resident in the US and do not receive income from US sources (citizen-based taxation). This makes it only one of two countries that tax their citizens regardless of their residence. The other country is Eritrea.

All other countries generally only tax individuals on their worldwide income if they are resident in the respective country. With certain exceptions, this also applies to German citizens who are resident abroad. As a rule, Germany only taxes the income of non-resident individuals if it comes from German sources.

It is quite obvious why a double taxation scenario arises when US citizens are resident in Germany. Germany taxes these individuals on their worldwide assets because of their tax residence in Germany; the US taxes the same individuals on their worldwide assets because they are US citizens.

In many cases, the problem of double taxation is eliminated or mitigated in the US if the income comes from non-US sources. In these cases, the US grants tax relief through the Foreign Tax Credit or the Foreign Earned Income Exclusion.

More problematic are cases in which US citizens residing in Germany receive income from US sources. This applies, for example, to payments from qualified US retirement plans (such as 401(k) plans or IRAs). In these cases, the relief provisions of US tax law do not apply.

One would assume that the double taxation convention between Germany and the US (DTC USA) would remedy this situation. This is indeed the case for German citizens who have lived and worked in the US, participated in qualified US retirement plans there, and receive payments from these plans after returning to Germany. According to the relevant provisions of the DTC US, these payments are only taxed in Germany.

The situation is different for US citizens. This is due to the so-called “saving clause” (Article 1 (4) DTC USA). It states the following:

Except to the extent provided in paragraph 5, this Convention shall not affect the taxation by the United States of its residents (as determined under Article 4 (Residence)) and its citizens.

This means that the US does not have to apply the relief provisions of the DTC USA to its own citizens. The US has incorporated such provisions into all DTCs with other countries in order not to lose the right to tax its own citizens. Therefore, if (partial) double taxation occurs, this is not due to taxation in Germany, but to the United States' unrestricted right to tax its own citizens.

It should be noted, however, that under Article 23(5) of the US DTC USA, the United States must credit the German income tax attributable to this income in the United States under the conditions specified therein.

If German income tax is higher than US income tax, this results in an additional tax burden. However, this is only due to the higher tax level in Germany.

If the tax burden in Germany is lower, only the lower German income tax is credited in the US. This may be the case for certain lifetime pensions from the US. In this case, residual taxation in the US remains, which is based solely on the unrestricted taxation rights of the US.

Author: Peter Scheller, tax advisor, Master of International Taxation

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