US-Citizens living and working in Germany (1)
von Peter Scheller
Tax Issues in Germany – Part 1
Living and working in another country requires careful tax planning as there are always many tax issues to be considered. In addition, social security and other legal issues such as immigration law must be observed. This applies for all US citizens who relocate to Germany and it is important to note that there are special issues to be observed. Different tax and social security systems in Germany and the USA may cause problems in addition to those contained in special provisions in the Double Taxation Convention between Germany and the USA (DTC USA).
There are several special arrangements of a general nature to consider for employees and for self-employed persons, for shareholders of US companies and for pensioners living in Germany.
There are two parts with 10 different special issues:
Income from capital investments
Income from real estate
The obligation to file income tax returns in Germany
Income from US companies
Salaries paid by US employers to US citizens living in Germany
Payments out of US pension plans
German social security system
Trust taxation in Germany
1) Saving clause
Germany taxes individuals if they are tax resident in Germany. This is the case if a person has a home or a habitual abode in Germany. A habitual abode is generally for a person who stays in Germany for a period of more than 183 days per year (more information here).
The USA follows another concept. It not only taxes people who are resident in the US but also its citizens regardless of where they live. They may live for decades abroad but are nevertheless liable to tax in the US. This even applies for persons who have two citizenships, such as from both Germany and from the USA.
It is clear therefore that this difference in tax treatment may result in a double taxation scenario for US citizens who live in Germany. On top of this most of the beneficial provisions of the Double Taxation Convention Germany/USA (DTC USA) are not applicable for US citizens because of the saving clause (Art. 1 (4) DTC USA). The Department of the Treasury defines the saving clause in its technical explanations as follows:
The United States reserves the right, except as provided in paragraph 5, to tax its residents and citizens as provided in its internal law, notwithstanding any provisions of the Convention to the contrary.
There are only very few exceptions to this, as stated in Art. 1 (5) DTC USA.
A double taxation liability can be avoided in most cases by special provisions of the US income tax law. This is either the Foreign Earned Income Exclusion or the Foreign Tax Credit. However, even if a US citizen does not pay any income taxes in the US he or she has to file at least Federal income tax returns. If this person holds at any time in a calendar year bank accounts or security accounts in a foreign bank with a total value of more than US-$ 10,000 this person has to file a FBAR (Foreign Bank and Financial Account Report) to the Treasury Department.
2) Tax assessment
The US tax declaration system is based on the principle of self-assessment. A US tax resident or US citizen has to file Federal and State income tax returns, calculate his or her tax liability and pay the tax on the basis of this self calculation.
The German tax system functions differently. A person has to file a yearly income tax return and send it to the relevant tax office by 31 July of the following year. The person does not have to calculate his or her tax liability and does not have pay the final tax instalment before receiving an income tax assessment note (Einkommensteuerbescheid). The assessment note comprises the tax relevant data, the tax calculation including the deduction of withholding taxes and states the deadline for tax payments.
Expatriates from countries with a self-assessment system often do not understand that a tax assessment note, produced on grey recycling paper, is the most important document he or she receives from the tax office. Often expatriates ignore it with unpleasant legal consequences. There might be mistakes in the tax calculation, or the tax authorities may have taken a different legal interpretation about tax relevant issues, which can result in a higher tax liability than expected. In general, the taxpayer has a one-month deadline to file a protest against an incorrect or legally questionable assessment note. Changes of the tax assessment at a later stage are in general not possible even if the tax assessment is obviously wrong. Therefore action has to be taken within the one month period.
More information can be found here.
3) The obligation to file income tax returns in Germany
German income tax law distinguishes three types of individuals:
- Persons with other income
- Persons with income from capital investments
The obligation to file a German income tax return follows different rules for each of these cases.
It is also possible to apply for a non-obligatory tax assessment. This makes sense if a tax refund is expected or other tax relevant issues need to be declared (such as a loss carried forward). Income tax returns have also to be submitted if requested by the German tax authorities.
The deadline for submitting an income tax return is the 31 July of the following year. A deadline extension is possible in justified cases. If a German Tax Adviser is engaged to file the income tax return an automatic extension to the 31 December (or even a later date) is applicable. However, German tax authorities may request an earlier date of submission. Missing the deadline may result in a penalty up to 10% of the tax due but not more than 25,000 Euro.
There is no obligation for an employee to file an income tax return if he or she only receives salaries or fringe benefits in Germany which have been subject to the German withholding wage tax. There are various exceptions to this rule (§ 46 Income Tax Code). In international cases individuals have to file a German income tax return if the following applies:
- Relocation to or out of Germany has occurred within a calendar year
- Salaries and benefits have been derived from foreign sources (e.g. from US employers)
Individuals who have income from trade and business or as a self-employed person, rental income or as pensioners have to file German income tax returns if their overall taxable income exceeds the general allowance. The general allowance for 2020 is for single assessment 9,408 Euro and for joint assessment 18,816 Euro. The allowance is amended every year for inflation.
An obligation to file an income tax return is applicable for persons with income from capital investments if the following applies:
- The maximum amount (lump sum) of deductible expenses reported to more than one financial institute exceeds 801 Euro (single assessment) or 1,602 (for joint assessment)
- No German tax was withheld by the financial institute or the debtor (e.g. private loans, capital income from foreign sources)
- The income has to be taxed at the progressive German income tax rate (e.g. income from silent partnerships, capital income from own businesses)
4) Salaries paid by US employers to US citizens living in Germany
If a US citizen works for a US employer and lives in Germany the following applies. The expatriate is tax liable in the US for his worldwide income. Salaries and fringe benefits will be treated as ordinary income. The saving clause (see section1 above) allows the US to tax the salaries of US citizens regardless of the place where the work is performed.
Normally Germany will tax the salaries and fringe benefits only if the work is performed in Germany. Salaries for work which is performed in the US will not be taxed in Germany if the employer is situated in the US. However, the tax free income will have an effect on the German income tax rate. The US will credit the German tax against the US income tax up to the US income tax due for the work in Germany. However, often salaries up to about 100,000 US-$ will not be taxed in the US if the employee applies for the Foreign Earned Income Exclusion (see section 1 above).
Job related costs which are in respect of the above mentioned tax-free income (e.g. expenses for travel to the US) are not tax deductible in Germany. However, they will be deducted from the tax-free salary and therefore reduce German income tax rate. The tax-free income and expenses related to this income have to be declared in the German income tax return.
Salaries related to work performed in the US can be calculated as follows:
Salary or other benefits multiplied by Days of work performance (1) in the US in respective period
divided by Days of work performance (2) in total in respective period
Days of work performance (1) are those days which have been agreed upon and the work has been undertaken in the US. Days of work performance (2) are the total days in the respective period which have been agreed upon. Days of travelling to the US will be considered as days of work performance in the US.
The part of the salaries and fringe benefits for work being performed in Germany trigger German income tax and solidarity surplus charge. The progressive income tax rate (up to 45%) is applicable.
Payments to US company pension plans (for example A 401(k)-plans) have the following tax implications in Germany:
- Income earned by the pension plan will not be taxed in Germany as long as there are not payments to or on behalf of the beneficiary. If payments are made to the beneficiary are they taxed?
- Contributions paid by the employee to the plan will be tax deductible. Contributions paid by the employer to the plan will not be taxed. However, two preconditions have to be fulfilled. Firstly, the first payment to the plan must be made before the employee starts an employment in Germany. Therefore, the plan cannot be established if the employee already works in Germany. Secondly the benefits must be limited to the maximum amounts which are applicable to contributions to respective statutory? German plans. Contributions paid by the employer are limited to 8% of the earning limit of the social pension system. The earning limit for 2020 is 79,488 Euro. Any amount in excess of 8% of this limit will be taxable income. Therefore, it might be advisable to adjust employee’s and employer’s contributions to the 401(k) plan in order to stay within the German limits. This is especially the case if the employee pays also into the German social security system or is participant in a “qualified” German pension plan.
5) German social security system
Every employee who works in Germany becomes in general liable to make contributions to the German social security system. It does not matter if the employer is situated in Germany or not, nor if the employee is insured in a foreign social security system: these circumstances have no relevance. The only exception from this general obligation is if a foreign employer sends an employee to Germany for a certain period and the employee remains an integral part of the employer’s organization (for more information see here)
If this exception is relevant to the case in question, it is advisable to enter into a separate assignment agreement proving that the before mentioned criteria are fulfilled.
The German social security system includes:
- Health insurance
- Nursing care insurance
- Pension insurance
- Unemployment insurance
- Accident insurance
For US citizens it is important to understand that the German social security system is very different from the US system. First of all social security contributions are not taxes in Germany. The contributions are not collected by the tax authorities but by social security agencies and certified health insurance entities. As a consequence separate declarations have to be filed and handed in to these agencies. This means that the employer has to do payroll accounting, produce pay-slips, file social security declarations and pay both the employer’s and employee’s part of the contributions. The employer has to store all relevant documents for x years?.
A US employer is in an unusual situation due to the fact that for tax purposes the company is not considered to be a German employer. If the employer has no permanent establishment or permanent representative in Germany it cannot withhold income tax for his or her employees or declare and pay taxes. The employee is obliged to file his or her income tax return (see section 2 above). However, for social security contributions other rules apply. A US employer can fulfil the above mentioned obligations in the same manner as a German employer. However, the US employer is not actually obliged to fulfil these obligation: if the employer does not do so the employee has to fulfil the respective obligation himself or herself.
Often US citizens and their US employers try to avoid the German social security contributions (especially if social security taxes are paid in the USA). There are various ways to achieve this:
- Freelancer: A route often taken is that the employee works as a freelancer for his former employer. Self-employed people are in general not liable to German social security contributions. However, there is the risk that German social security agencies consider this a false self-employment, but up to now the agencies do not follow up these cases. For more information see here.
- Assignment: If the employer has an interest in sending the employee to Germany and the employee remains integrated in the employer’s organization, both parties should enter into an assignment contract. In this way, the employee will remain in the US social security system. For more information see here.
- German social health insurance: in general, every person who is living in Germany is obliged to have a basic health insurance cover. If this person works as an employee in Germany he or she is subject to the German social security system (if not be assigned to Germany). I am not quite sure about this previous point and what the words in the brackets mean. However, employees are not obliged to be within the German social health insurance system if their salaries exceed certain maximum amounts. For 2020 these amounts were 4,687.50 Euro per month or 56,250 Euro per year. Therefore employees who earn more than above mentioned amounts will not be obliged to pay into the social health system. A foreign health insurance is sufficient if it provides the same cover as the basic German social health insurance. US Medicare fulfils this criteria.
- German social pension insurance: An employee can avoid the German social pension insurance only if he or she either will be assigned by his employer to Germany or if he or she is self-employed. However, there is a possible way to reduce the unfavorable consequences of making such payments. Contributions paid into the social pension insurance system can be refunded if an employee has paid contributions for less than 60 months (5 years). If the employee leaves Germany after less than 5 years he or she may be entitled to a refund of the employee’s part of the contributions. However, there is also a risk here because Germany and the US have entered into a Social Security Agreement (Totalization Agreement). It is not absolutely clear whether the 5 year period is only limited to payments into the German system or periods of payments into both systems added together. If they are added and exceed together the 5 year period, the employee may not be able to apply for a refund and the employer’s part of contributions will not be refunded at all. Therefore it seems advisable to avoid the German social pension system altogether.
Author: Peter Scheller, German tax adviser, Master of International Taxation
- health insurance
- income tax
- income tax return
- pension plans
- Saving Clause
- social security
- tx residence; tax assessment
- US employer