There is no good answer to this question. To start with the bad news: There is a chance Germany will try to tax both fully. How is that? First, a mid-level tax administration in the Northern part of Germany has plain and simple published a local directive saying that OPM benefits belong to Germany. No reasons provided, but any malevolent tax office might just pull this directive out and use it against you. Second, when it is your surviving spouse, that receives OPM benefits, but happens to (also) be a German national, the German tax office might just argue that the US-German tax treaty assigns taxation of those benefits to Germany due to your surviving spouse’s German citizenship. Third, they like to argue that a TSP is a retirement plan pretty much like the usual ones (IRAs, 401k…), for which the taxation rights actually belong to Germany if this is your country of residency under treaty. Unfortunately, you will also find matter-of-fact statements online, which will argue the tax office’s way.
So far so bad. However, there is light as well. We are convinced that OPM benefits can only be taxed in the US and can only be considered for tax bracket purposes in Germany. We do not find it very hard to find compelling arguments as to that in the above-mentioned mid-level directive itself as well as the tax treaties from 1989 and 2008 between the US and Germany.
We are also convinced that TSP benefits are pensions for government service and hence equally subject only to taxation in the US. Our arguments as to this stance can actually be found in the US code and the TSP structure along with the 2008 tax treaty protocol.
Now, how would you go about this issue when having the taxperts file your German tax return? Essentially, we treat your OPM and TSP benefits the way we are convinced they need to be treated. This means we will not subject them to German taxation. Since the German tax office typically always has questions about the origin and calculation of foreign income, we will use any question on your return to present our arguments. If the tax office accepts our take (which it has always done so far after some more or less heated exchange), you are good, and the chances are high that this issue will not re-surface.
Please let us know if you are drawing TSP and or OPM benefits (or are about to) and have questions about their taxation in Germany.
