German tax law knows two concepts of considering foreign income for German tax purposes. One is to include the income fully in the German tax base and then tax it at the normal rates. Depending on the income one might get credit for taxes paid elsewhere on the same income or not – the result being that one would need to go back to the foreign tax system and seek a refund. Credit of foreign taxes e.g. is given for US dividends, but not retirement plan payouts, interest, royalties, brokerage or freelance profits.
Another is to keep the income excluded from the German tax base but consider the foreign income in the tax rate or tax bracket. It means that your foreign income will put you in a higher or sometimes lower tax rate, which is being applied to your other German tax base. However, while it sounds simple, it is a bit more complex than what meets the eye.
First, the foreign income to be considered for German tax rate purposes must be calculated in accordance with German tax law. For this reason, differences arise in the area of foreign rental income, because the depreciation schedules rarely ever align. Second, some foreign passive income will only be considered to put you in a higher tax bracket, but never a lower one. Third, if you want the income excluded in Germany, you need to be able to show that it was taxed elsewhere already. Otherwise Germany might pull a so-called unilateral treaty-override and tax our foreign income regardless just to make sure it does not go completely untaxed!
Typical sources of US income which are certainly exempt from German taxation and can only be considered for tax purposes are US government pensions or US real estate income. US income which comes with some contestation are TSP payouts and government benefits paid to German surviving spouses. Actually free of consideration for German tax base and German tax bracket effect should be VA benefits and any benefit paid as compensation for war- or service-related injuries.
Social Security benefits on the other hand are mostly always included in the German tax base.
US tax law know similar mechanism when considering foreign income, they are called foreign earned income exclusion and foreign tax credit. The two definitely have different requirements and those requirements differ from the German tax law.
