US taxes while living in Germany: FBAR, FEIE and foreign tax credits

Moving to Germany does not end your relationship with the IRS. The United States taxes its citizens on worldwide income wherever they live, so an American working in Germany normally files both a German return (where required) and a US return every year.

I lived and worked in Germany and dealt with both systems. The good news is that, for most employees, the US tools for avoiding double taxation work well. The work lies in knowing which forms apply and keeping the deadlines. This guide summarises the IRS rules as published on irs.gov. It is general information, not tax advice; for your own situation, use IRS Publication 54 or a qualified preparer.

The basic rule: worldwide income

The IRS states that if you are a US citizen or resident alien, the rules for filing income, estate and gift tax returns and paying estimated tax are generally the same whether you are in the United States or abroad. You are taxed on worldwide income from all sources.

That includes your German salary, interest from a German bank account, rental income and investment income. The IRS also points out that Americans abroad can only use benefits such as the foreign earned income exclusion and the foreign tax credit by filing a US return. Not filing because "I paid tax in Germany" forfeits those benefits.

Deadlines for Americans abroad

• Regular due date: April 15 for calendar-year taxpayers.
• Automatic two-month extension: if you are a US citizen or resident alien residing overseas on the regular due date, the IRS allows an automatic extension to June 15 without requesting it. If the date falls on a weekend or legal holiday, it moves to the next business day.
• Further extension: you can request an extension to October 15 by filing Form 4868 before the automatic June date.
• Interest: even with an extension, interest is charged on tax not paid by the regular April due date.

Germany's own filing calendar is different. German income tax returns are generally due seven months after the end of the calendar year under the Fiscal Code, and later when prepared by a tax adviser. Plan both calendars together, because you need German figures for the US return if you claim the foreign tax credit.

Option 1: the foreign earned income exclusion (FEIE)

The FEIE lets qualifying taxpayers exclude foreign earned income from US income, up to an annual limit adjusted for inflation. To qualify, according to the IRS, you need foreign earned income, a tax home in a foreign country, and to meet one of two tests:

• Bona fide residence test: you are a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year.
• Physical presence test: you are physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

Your tax home must be abroad. The IRS notes you do not have a foreign tax home if your abode remains in the United States, where you keep closer family, economic and personal ties.

You claim the exclusion on Form 2555. Check the current year's limit in the Form 2555 instructions, because it changes every year. A few points from the IRS:

• The exclusion applies to earned income, such as wages and self-employment income, not to interest, dividends or pensions.
• For self-employed people, the exclusion reduces regular income tax but not self-employment tax.
• If you claim the exclusion, tax on your remaining income is figured at the rates that would have applied without the exclusion.
• There is also a foreign housing exclusion or deduction for certain housing costs.

Option 2: the foreign tax credit (FTC)

The foreign tax credit lets you credit income taxes paid to Germany against US tax on the same income. The IRS states that only income, war profits and excess profits taxes generally qualify, and that in most cases taking the credit is more advantageous than deducting foreign taxes as an itemized deduction. Individuals claim it on Form 1116.

Germany's income tax rates for employees are often higher than US federal rates on the same salary. As a result, many Americans working in Germany find that the credit covers their US tax on German wages. Whether the FEIE or the FTC works better depends on income level, family situation, other income and future plans, so compare both.

One rule matters a great deal: you cannot take a foreign tax credit for taxes on income you exclude under the FEIE. If you claim the credit on income after electing the exclusion, the IRS warns that the election may be considered revoked. Choose carefully, because changes have consequences for later years.

If German tax figures change after you file, for example after a German assessment notice, the IRS says that a redetermination of your US tax liability is generally required, using an amended return. Watch for this when the German notice arrives after you have filed your US return.

The US-Germany income tax treaty

The United States and Germany have an income tax treaty. The IRS lists the 1989 income tax treaty and its technical explanation, plus a 2006 protocol with a 2007 technical explanation, on its Germany tax treaty documents page.

The treaty decides, among other things, which country may tax certain types of income and how residence conflicts are resolved. Most US treaties contain a "saving clause" allowing the US to tax its citizens as if the treaty did not exist, with listed exceptions. Read the treaty text or ask a preparer before relying on a treaty position, and note that treaty-based return positions can require a disclosure form.

FBAR: reporting your German accounts

The Report of Foreign Bank and Financial Accounts (FBAR) is separate from your tax return.

• Who files: a US person whose foreign financial accounts had an aggregate value exceeding 10,000 dollars at any time during the calendar year.
• What counts: bank accounts, brokerage accounts and mutual funds, among others.
• When: due April 15, with an automatic extension to October 15. You do not need to request the extension.
• How: electronically on FinCEN Form 114 through FinCEN's BSA E-Filing System, not with your tax return.
• Records: keep account records for five years from the FBAR due date.

The FBAR is a reporting obligation, not a tax. It applies even when the accounts earn nothing.

Form 8938: FATCA reporting

Form 8938 is attached to your tax return when your specified foreign financial assets exceed the thresholds. For taxpayers living abroad, the IRS lists these thresholds:

• Single or married filing separately: more than 200,000 dollars on the last day of the year or more than 300,000 dollars at any time during the year.
• Married filing jointly: more than 400,000 dollars on the last day of the year or more than 600,000 dollars at any time during the year.

You count as living abroad for this purpose if you are a US citizen whose tax home is in a foreign country and you meet the bona fide residence test or are present abroad for at least 330 days in a consecutive 12-month period. Failure to file can bring a 10,000 dollar penalty and further penalties after IRS notification.

Many people file both an FBAR and Form 8938 for the same accounts. That is expected; the forms have different rules.

German pensions and investment funds

Some German products raise US questions. German pension schemes and certain savings plans can carry US reporting requirements, and the IRS notes that US persons with transactions involving foreign trusts, which can include some foreign retirement plans, may need Form 3520. Non-US investment funds can be treated as passive foreign investment companies under US rules. Ask before you buy a German investment fund or sign up for an employer pension plan.

A yearly routine

1. January to March: collect German payslips, the annual payroll tax certificate and bank statements.
2. Track your days abroad if you rely on the physical presence test.
3. April 15: note the regular deadline, even if you use the automatic June extension.
4. Pay any expected US tax by April 15 to avoid interest.
5. File the FBAR by April 15, or by October 15 under the automatic extension.
6. Attach Form 8938 to your return if you exceed the thresholds.
7. File your German return on the German schedule and amend the US return if German figures change.

Common questions

Do I have to file a US tax return if I live in Germany? Yes, if you meet the normal filing requirements. US citizens are taxed on worldwide income, and the exclusion and credit are only available if you file.

When is my US return due if I live in Germany? April 15, with an automatic two-month extension to June 15 for citizens residing abroad. Form 4868 can extend to October 15. Interest runs from April 15 on unpaid tax.

Can I use both the FEIE and the foreign tax credit? Not on the same income. You cannot take a credit for taxes on income you exclude. You can use the credit on other, non-excluded income.

Is there a US-Germany tax treaty? Yes. The IRS lists the 1989 income tax treaty and a 2006 protocol, with technical explanations, on its Germany treaty documents page.