For Americans living in Germany investment income is usually not the most intuitive tax topic to begin with. Dividends, interest, capital gains, rental income or fund distributions need to be understood under German tax law, US tax law and, depending on the item, the US-German tax treaty. Most of the time this is tedious but manageable because foreign taxes paid can at least somehow be worked into the US foreign tax credit system.
However, there is one US tax item where this logic hits a wall: the Net Investment Income Tax, or NIIT.
The NIIT is a 3.8% US tax on certain investment income once your income crosses the applicable threshold. For single filers and heads of household the threshold is currently $200,000, for married filing jointly it is $250,000 and for married filing separately it is $125,000. The income caught by the NIIT can include items such as interest, dividends, capital gains, rental income and other passive investment income.
For a US person living in the United States this may already feel unpleasant enough. For a US person living in Germany the issue can become particularly annoying because the same investment income may already have been taxed in Germany. Under the usual foreign tax credit mechanics one would expect the German tax to offset the corresponding US tax. With the NIIT this is where the fun stops.
The reason is very technical and very simple at the same time. The regular foreign tax credit rules apply to regular US income tax. The NIIT, however, is not located in the same chapter of the Internal Revenue Code as regular income tax. It sits in its own corner and is labelled as an “Unearned Income Medicare Contribution”. The IRS therefore does not treat it like regular income tax for foreign tax credit purposes. The result is that German income tax paid on the same investment income generally cannot be used to offset the 3.8% NIIT under domestic US law.
Yes, this means what you think it means. You may pay German tax on your investment income and still owe the NIIT in the US on that very same income. And to add insult to injury, as an American living in Germany you generally do not receive meaningful Medicare access in return for this particular contribution.
Not surprisingly, taxpayers have started fighting this. Two cases are currently receiving significant attention: Christensen v. United States, involving US citizens living in France, and Bruyea v. United States, involving a US citizen in Canada. In both cases the taxpayers argued that the applicable tax treaty provided an independent right to a foreign tax credit against the NIIT, even if domestic US law would not.
At trial level, both taxpayers won. The courts essentially accepted that the treaty language aimed at eliminating double taxation could matter independently from the domestic placement of the NIIT in the tax code. The US government appealed, and the cases are now before the US Court of Appeals for the Federal Circuit. As of this writing, the final word has not been spoken yet.
So what does this mean for Americans in Germany?
First, it does not mean that everybody living in Germany can now simply claim a foreign tax credit against the NIIT. The cases are based on the specific wording of the France-US and Canada-US tax treaties. The Germany-US tax treaty has its own language and structure. Even if the taxpayers ultimately prevail, the reasoning of the Federal Circuit will need to be analyzed carefully before applying it to Germany.
Second, it does mean that the NIIT issue should not be ignored. If you are paying NIIT while also paying German tax on the same investment income, you should keep clean documentation. This means tracking the investment income, the German tax paid on that income, the NIIT calculation and the relevant US filings. Should the legal landscape shift in favor of taxpayers, proper documentation may be the difference between a workable refund claim and a frustrating guessing game.
Third, we would be careful with aggressive positions until there is more certainty. Claiming a credit against the NIIT while the appeal is unresolved may look tempting, but if the government ultimately wins you could be looking at tax, penalties and interest. We understand the frustration, but we are not great fans of turning a legitimate tax issue into an unnecessary fight with the IRS before the battlefield is clear.
For the German side of the equation the issue also highlights why investment reporting for Americans in Germany is rarely just a “copy the 1099” exercise. German taxation of investment income follows its own rules. US taxation follows its own rules. The treaty may allocate rights one way or another. And then the NIIT comes in and tries to collect another 3.8% on top, while pretending the regular foreign tax credit world is none of its business.
We think the current litigation is important because it may finally address a real double-taxation problem for Americans abroad. Whether it will help Americans living in Germany will depend on the final ruling and, most importantly, on how the court reasons its way there.
Until then, the practical recommendation is fairly boring but important: do not lose the paperwork. Track your NIIT. Track your German taxes. Keep the returns and supporting documents. If a refund window opens later, you want to be ready.
Please let the taxperts know if you are paying NIIT on investment income while living in Germany and are wondering whether this affects you. We are watching the development closely and are happy to help you evaluate whether your situation should be preserved for a potential future claim.
