Understanding the US German tax treaty is crucial for American living in the Germany and to Germans who have US source income. This comprehensive guide breaks down the treaty's provisions, offering clarity on how it affects personal taxation and helps avoid double taxation.
Executive Summary
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Introduction to the US German Tax Treaty
The US German tax treaty, originally signed in 1989, serves as an agreement between the two countries for determining the taxation of income where both nations may have the legal right to tax according to their respective laws. The treaty covers how to determine tax residency and discusses various forms of income, including business profits, dividends, interest, pensions, and capital gains. This article will focus on key aspects of the treaty that hold particular significance.
Relief of Double Taxation
The US German tax treaty provides mechanisms for relief from double taxation, ensuring that income earned in one country by residents or citizens of the other is not taxed twice. Specifically, the treaty allows U.S. citizens and residents to claim a foreign tax credit for the income tax they pay to Germany against their U.S. tax obligations. Conversely, Germany offers a credit for U.S. taxes paid against the German tax liabilities of its residents.
Example of Avoiding Double Taxation
Alexander Dietrich, a U.S. citizen residing in Munich, Germany, earns an annual salary of $80,000. In Germany, he incurs $25,000 in taxes for the year. Alexander's U.S. tax liability for this income amounts to $22,000. Thanks to the relief of relief of double taxation provision of the tax treaty, he is entitled to claim a foreign tax credit. Alexander applies the $25,000 he paid in German taxes against his U.S. tax obligation, effectively reducing his U.S. tax liability to zero and even generating a $3,000 credit surplus, which may be applicable for carryover to subsequent tax years.
The Savings Clause
The US German tax treaty contains a "savings clause" which allows the U.S. to impose taxes on its citizens according to its own laws, even if this contradicts the stipulations of the treaty. As a result of this clause, for U.S. citizen expats, the majority of the benefits and reductions offered by the treaty do not apply.
Example of the Savings Clause Nullifying a Tax Treaty Benefit
Sarah Johnson, a U.S. citizen and software developer, lives and works in Berlin for an American tech firm. She conducts all her work in Germany and maintains no physical establishment in the U.S. Despite the U.S. German tax treaty typically exempting such income from U.S. tax when there's no permanent establishment stateside, the savings clause overrides this, requiring Sarah to declare and possibly pay U.S. taxes on her income. Nevertheless, Sarah can take advantage of foreign earned income exclusions or tax credits for the taxes paid in Germany to avoid being taxed twice on the same income.
​Expert Tip: It's crucial for U.S. citizens to familiarize themselves with the Savings Clause exclusions in the US German Tax Treaty to accurately determine which tax benefits they can utilize. |
Tax Residency and the Tie-Breaker Rules
The United States and Germany each have their own criteria for determining who is a resident for tax purposes. It's possible for someone to meet the residency requirements of both countries simultaneously. To prevent the problems that dual residency could cause, the U.S. Germany Tax Treaty provides a series of tie-breaker rules. These rules help to decide which country has the primary right to tax the individual's income.
Permanent Home Test: The first consideration is whether the individual has a permanent home available to them in one of the countries. If a permanent home is available in only one country, that country is generally considered the individual's country of residence for tax purposes.
Centre of vital interests Test: If the individual has a permanent home in both countries or in neither country, the treaty looks at where the individuals center of vital interests lies, in other words, where they have a closer personal and economic interests.
Habitual Abode Test: If the individual has a center of vital interests in both countries or in neither country, the treaty looks at where the individual has a habitual abode; in other words, where they live regularly. This could be where they spend more time or where they have a regular presence.
Nationality Test: If the individual has a habitual abode in both countries or in neither, the next factor considered is nationality. If the person is a citizen of only one of the countries, that country is typically considered their country of residence for tax purposes.
Mutual Agreement Procedure: In the rare case that the individual is a citizen of both countries or of neither, and the above tests do not resolve the issue of residency, the competent authorities of the United States and the Germany will determine the individual's residency through a mutual agreement, taking into account the person's facts and circumstances.
Taxation of US-Sourced Passive Income
Passive income from U.S. sources, which is not tied to a U.S. trade or business, is taxed at a flat rate of 30% if earned by a non-resident alien. However, the US German tax treaty may lower this rate or totally exempt it from US taxation for certain types of income. We've summarized some of the tax treaty rates in the table below. It's important to note that that these rates generally do not apply to U.S. citizens due to the savings clause mentioned earlier.
​ | ​Tax Rate | Treaty Article Citation |
​Interest | 0% | 11(1) |
​Dividends - Paid by U.S. Corporations | 15% | 10(2) / PIV |
Dividends - Qualifying for Direct Dividend Rate | 5% | 10(2) / PIV |
Pensions and Annuities | 0% | 18(1) |
Social Security and Alimony | 0% | 18(5) / PVIII |
Personal Service Income Earned While Temporarily Present in the US
Generally, income received from work performed in the US would be considered US source income and would be subject to US taxation. However, the US German tax treaty lists certain exemptions where taxes rates are reduced or even eliminated. It's important to note that these exceptions generally do not apply to US citizens because of the savings clause mentioned earlier. We've summarized some of these exceptions in the table below:
​Income Type | ​Maximum Presence in U.S | Required Employer or Payer | Maximum Amount of Compensation | Treaty Article Citation |
​Employee | 183 days | Any foreign resident* | No limit** | 15 |
Contractor | Treated as business profits under Article 7 (VII) of the treaty | 7 | ||
​Public entertainment | No limit | Any U.S. or foreign resident | $20,000 | 17 |
​Teaching*** | 2 years | U.S. educational or research institution | No limit | 20(1) |
​Full-Time Students - remittances or allowances | No limit | Any foreign resident | No limit | 20(2) |
​Full-Time Students - Compensation during study | 4 years | Any U.S. or foreign resident | ​$9,000 | 20(4) |
​Full Time Students - Compensation while gaining experience | 1 year | Any foreign resident | $10,000 | 20(5) |
*The exemption does not apply if the employee's compensation is borne by a permanent establishment that the employer has in the United States. **Fees paid to a resident of the treaty country for services performed in the United States as a director of a U.S. corporation are subject to U.S. tax.
***Does not apply to compensation for research work primarily for private benefit.
Totalization Agreement
The United States and the Germany have a totalization agreement in place, which is designed to avoid double taxation of their income with respect to social security taxes. It establishes clear rules about which country's social security system covers the employee. As a result, employees and their employers can only be taxed by one country's social security system at a time.
State Taxes and the US German Tax Treaty
Numerous states within the United States impose income taxes on their residents. The adherence to U.S. tax treaty provisions varies by state—some may recognize them, while others may not.
​Expert Insight: Always check with a tax professional about how state tax laws interact with the treaty, as this can vary significantly from state to state. |
Need Help Navigating the US Germany Tax Treaty?
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Frequently Asked Questions
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Authored by Lewis Grunfeld, CPA
Lewis is a seasoned expert in international and U.S. expatriate taxation. With over 10 years of international tax experience, he specializes in applying tax treaties to benefit expats, handling complex tax scenarios and ensuring significant tax savings for his clients. Lewis's expertise in international compliance and U.S. expat tax returns has made him a trusted advisor in the expatriate community.