Inheritance Tax for US citizens - 10 year domicile law

79 posts in this topic

 

2 hours ago, Straightpoop said:

The case discussed is simply not relevant to gifts/inheritances governed by foreign law for which German law has no equivalent.

 

Ah well, but article 12 (1) of the 1982 double taxation treaty on inheritance tax between Germany and the US does give Germany the right to apply its own rules to trusts.

 

See the commentary of Troll, Teilziffer 133-135:

133 Ist der Trust nur nach ausländischem Recht wirksam errichtet, aus deutscher Sicht aber – zumeist – erbrechtlich oder sachenrechtlich unzulässig, wird auf Grund der isolierenden Betrachtungsweise die deutsche Qualifikation maßgeblich sein: Unzweifelhaft entfällt damit eine Steuerpflicht, wenn z. B. die Übertragung auf den Trust an sachenrechtlich dem deutschen Recht unterlegenem Vermögen wegen der gespaltenen Rechtsinhaberschaft (Tz. 118) gar nicht zulässig ist und nicht zustande kommt (Götzenberger, S. 83; Wienbracke, ZEV 2007, 413, 418). Das Gleiche gilt, wenn es bereits nach der Zielsetzung des Trusts an einem rechtlichen Übergang von Vermögenswerten überhaupt fehlt, etwa bei einem bloßen fiktiven Trust („constructive trust“, vgl. Tz. 117). Den vorstehenden Fällen ist gemeinsam, dass überhaupt keine Vermögensübertragung stattfindet und es damit an einer freien Verfügungsbefugnis der ausländischen Vermögensmasse entsprechend den Mindestvorgaben des BFH v. 28. 6. 2007 II R 21/05 (Tz. 129) fehlen muss. Schwieriger zu beurteilen sind die Fälle, in denen im Ausland für dort belegenes Vermögen der Trust anerkannt und abgewickelt wird, aber zumeist aus nicht vermögensbezogenen, sondern erbrechtlichen Gründen in Deutschland immer noch zivilrechtlich unzulässig ist. Auf Grund der isolierenden Betrachtungsweise und der Maßgeblichkeit des Zivilrechts bei den Tatbeständen des § 3 ErbStG (vgl. Einf./Tz. 29 ff.; § 3/Tz. 4 f.) wird eine Besteuerung nur entsprechend den im deutschen Zivilrecht entwickelten Umdeutungsergebnissen in Betracht kommen. D. h. es findet z. B. kein Erwerb des Trusts in Steuerklasse III, sondern ein Direkterwerb des Begünstigten nach dem Verwandtschaftsverhältnis zum Gründer, evtl. in Steuerklasse I statt (ebenso Birnbaum/Lohbeck/Pöllath, FR 2007, 479, 481; a. A. evtl. Halaczinsky, NWB (1999) F. 10, 906).

134 Die Besteuerung kann weiter dann – jedenfalls nicht als Erwerb einer Vermögensmasse ausländischen Rechts – einsetzen, wenn zwar mit dem Tod des Trustgründers seine Sonderrechte enden, aber unmittelbar ein – die notwendige Bindung der Vermögensmasse ausschließender – Soforterwerb des Erwerbers zu unterstellen ist (vgl. Tz. 132). Das ist dann der Fall, wenn er die jederzeitige Auskehrung des Vermögens an sich verlangen kann, z. B. auch der insoweit befugte alleinige Trustee ist (vgl. näher Jülicher, ZErb 2007, 361, 366). Hierfür wird man zwar nicht auf den Übergang des wirtschaftlichen Eigentums abstellen können (anders als im EStG, vgl. dazu BFH v. 25. 6. 2009 IV R 3/07, BStBl. II 2010, 182, zu § 16 Abs. 1 Nr. 2 EStG). Jedoch wird auch eine „Potestativbedingung“ (vgl. dazu § 12/Tz. 26) wohl dann nicht aufschiebend bedingt in Bezug auf die Steuerentstehung wirken können, wenn sie allein vom Willen des Erwerbers abhängt. Denn andernfalls hätte er es in der Hand, die Steuerentstehung beliebig hinauszuzögern.

135 Zuwendungen an einen Trust sind regelmäßig nach Steuerklasse III zu besteuern; denn das Steuerklassenprivileg nach § 15 Abs. 2 Satz 1 ErbStG greift nicht für die Errichtung einer im Ausland errichteten Vermögensmasse und ohnehin nicht für spätere Zuwendungen an diese Vermögensmasse auf Grund eines selbstständigen Entschlusses (vgl. § 15/Tz. 110, 112). Die ohnehin abzulehnende Auffassung der FinVerw, die spätere Änderung einer Stiftungssatzung – insbesondere die Erweiterung des Begünstigtenkreises – als fingierte Auflösung der Stiftung und Gründung einer neuen Stiftung anzusehen (§ 15/Tz. 107), wird von ihrem Regelungszweck für Trusts wie für ausländische Familienstiftungen bereits nicht in Betracht kommen. Sie wurde vor allem zu dem Zweck geschaffen, die Umgehung der Steuerklasse III bei Erstausstattung der inländischen Familienstiftung durch anfängliche Auslassung eines – nachfolgend durch Änderung der Begünstigtenregelung einbezogenen – in eine ungünstigere Steuerklasse eingruppierten „entferntesten“ Berechtigten iSd § 15 Abs. 2 Satz 1 ErbStG (vgl. § 15/Tz. 106 f.) zu vermeiden. Ein auslandsansässiger Trust erwirbt aber regelmäßig in Steuerklasse III; die Änderung der Satzung betrifft meist nur Steuerausländer (Götzenberger, S. 88).

 

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As I already said, I'm not quite so sure about the second alternative @Straightpoop proposed, but in my opinion for it to work, the money would have to be left to another physical person (i.e. not to a trust!) US resident, i.e. to someone you trust enough to be sure that person would cough up that money again once you've moved back to the US, who would then only dish out the money based on an unsure condition, which in no case should state "no longer having German residence" as its condition.

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@PandaMunich

 

All very interesting but, again, the primary concern of the quoted language is the tranfer TO a trust by a German tax resident.  Definitely not an issue in the case we are discussing which involves the creation of a foreign trust by a foreign person and then the taxability of distributions FROM the trust to a German tax resident. The author of the Kommentar seems fixated on the idea that foreign trusts are used to give the mere appearance of loss of title or control of assets - historically the way they were used in Germany.  He does not address the situation where the foreign settlor has died and there has been actual transfer of legal title to a foreign trustee and the trust instrument puts strictly enforceable conditions on distributions to a beneficiary allowed by the trust instrumentor or grants the trustee a level of discretion that makes it impossible to argue that a beneficiary has any legal power to control it.

 

A trust does not have legal personality but since the amendment of the ErbStG in the 1990's is now treated for German inheritance tax purposes as if it did. But again, that amendment was aimed at German tax residents who under the previous law were able to move assets outside of Germany through foreign trusts tax-free or tax-deferred. That is simply not what we are talking about here.

 

Your concerns about the reliability of trusts are misplaced.

 

Unlike the German position of "Treuhander" (often incorrectly translated as "trustee") or Testamentsvollstrecker, a US trustee is the actual legal "owner" of the assets held in the trust. That legal title to the assets is usually supplemented by whatever degree of management control and ultimate dispository authority is granted by the trust instrument and limited only by the trustees statutory or common law fiduciary responsibilities to the beneficiaries.

 

The reliability of trusts depends entirely upon the reliability of the trustee chosen by the settlor.  The trustee can be a natural person - chosen for their trustworthiness and/or knowledge of the settlor's desires or a corporate fiduciary (a bank, etc.).  In either case, the trustee has strictly enforceable fiduciary responsibilities to the beneficiaries and can be held personally liable for failure to meet them.  In America it is also very common for the settlor to require an individual personal trustee to post surety on their bond, i.e. insurance against failure to meet fiduciary responsibilities.

 

Satisfying the condition that the beneficiary not be a tax resident of Germany would be something exceedingly easy to do. The settlor could simply specify the proof required in the trust instrument, e.g. an opinion of counsel, statement from the Finanzamt, physical presence of beneficiary and family in the US for specified period, simple affidavit of the beneficiary, etc.

 

 

 

 

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@Straightpoop

So what would you amend in my previous opinion, i.e. what exactly should @Winger do?

 

On 10/24/2017, 9:26:24, PandaMunich said:

As I already said, I'm not quite so sure about the second alternative @Straightpoop proposed, but in my opinion for it to work, the money would have to be left to another physical person (i.e. not to a trust!) US resident, i.e. to someone you trust enough to be sure that person would cough up that money again once you've moved back to the US, who would then only dish out the money based on an unsure condition, which in no case should state "no longer having German residence" as its condition.

 

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@PandaMunich

 

@Winger

has a relatively simple problem.  He and his family will be exposed to German inheritance tax for only a foreseeably limited period of time:  4 years.

He says his parents are in their 70's but makes no mention of their health.  Nor does he mention any particulars of his parents existing estate plan or the size of the estate.

 

If, as most married couples do, Winger's parents have testamentary arrangements that provide for the survivor of them to receive all of their estate and nothing to children or others until the survivor dies, then both Winger's parents would have to die during his 4 year stay in Germany for there to be any exposure to German inheritance tax.  Thus, depending upon circumstances that are not known to us, the risk of that happening may be very small.

 

What is important, however, is that Winger now understands that there IS a risk and he fully understands its scope.  He is now in a position to communicate that risk to his parents so that they can take timely action to negate that risk - if they choose to do so.

 

The difficulty for Winger is first convincing Winger's parents and then their local estate planning professionals that the risk exists. The average estate planning lawyer in the US has little or no knowledge of inheritance tax systems generally and even less about such systems in foreign countries.  That is because the US Federal government and most of the individual states that have "death" taxes employ an estate tax rather than an inheritance tax.  Consequently, they have no experience drafting language to solve this sort of problem.  And, as our discussion illustrates, it may be very difficult for Winger's US legal advisors to find any German lawyers sufficiently knowledgeable about these issues to offer any useful assistance.

 

The key task for the Winger family's advisors is drafting appropriate language in Winger's surviving parent's testamentary instrument that strictly and unambiguously conditions Winger's right to inherit anything while he is tax resident in Germany upon facts and circumstances that Winger cannot control or to limit his inheritance to amounts within the Freibetrag.  The trust is the ideal instrument for that purpose and it is possible that Winger's parents already have trusts set up.  (In California, for example, just about everyone uses trusts for tranferring assets at death because California's statutory probate fees are so ridiculously expensive.)

 

So my advice to Winger:  Communicate.  Now.

 

 

 

 

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Hi, been quite sometime since I was on TT so please forgive me for my absence and then just selfishly jumping on to ask a question. I will try to stay on more often and offer input  where I can based on my knowledge.

 

Y’all did a great job of clarifying this topic but I’m hoping you could extend the Diskussion to cover inherited IRAs from the US (non-spouse and not a Roth) being inherited by US citizen with permanent German residence (11 years).  This is treated like income (not inheritance) in the US and my German Steuerberater does not know if I then pay tax again here.  Cane someone help? @Straightpoop and @Pandamunich, @Starshollow. Also happy for recommendations of someone I can work with here in Frankford area. Thanks all!

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Hi @Calendar21. Great question... looking forward to hearing the answers. This is of course a complicated topic. I'm not a pro, so hopefully my mini-answers don't get too shredded. =)

 

You (US citizen resident in Germany for 11 years) are subject to German inheritance tax. So first you have to deal with the topic of whether Germany will tax the full amount, when you file the German inheritance tax return that you are supposed to file. I suspect the opinion will be yes... assuming of course the amount is high enough to tax, depending on the relationship you had with the deceased. (child, grandchild, etc.)

 

https://www.expatica.com/de/finance/taxes/a-guide-to-german-inheritance-tax-inheritance-law-and-writing-a-german-will-108115/

 

In the US, the money is taxed like income when you take it out... all of it, assuming the money invested in the IRA was pretax, which isn't always the case. The US citizen can take the money out (other than RMD's), whenever you want, which doesn't align well with similar German accounts. So that always causes discussion here. You won't pay inheritance tax in the US, unless this is a ridiculously enormous IRA, or the IRA is part of an estate large enough to be taxed. You will not be double taxed for -income- tax, because what you pay the Germans when you take distributions, you get as a FTC on your US return. But since you almost certainly pay the US nothing for inheritance tax, there's no possibility of double taxation with Germany... Germany gets what they ask for. How do you pay Germany the inheritance tax, without taking the money out of the IRA and having to pay income tax on it? Good question. I would think if you don't have other funds to use, you would need to take out enough, so that after German income tax, you can still pay the German inheritance tax. Not fun. Would love to hear I'm wrong on that one.

 

Anyway, hopefully this is answered by the pros that you referenced... and I didn't screw up very much. =)

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@Calendar21

@StephenGermany

 

StephenGermany's summary is accurate.

 

The US tax consequences - both estate or income - are likely to be minimal.  (US State estate/inheritance/income taxes will be a factor only to the extent the German resident beneficiary has failed to effectively abandon the relevant US state domicile.)

 

German domestic tax law provides for double taxation of the value of inherited assets first under the inheritance tax (ErbStG) and again under the income tax (EStG) for so-called "latent income" whose value might have been included in the value previously subjected to inheritance tax.  Examples:

 

  • Unrealized (at death) capital gain contained in the fair market value of securities purchased by the decedent after 31.12.2008. ErbSt is computed on the market value of the securities (including their unrealized gain) at death and income tax is computed on the basis of the sales proceeds less the decedent's "carry over" cost basis. (No basis "step up" to FMV at death as is allowed under US law.)
  • Accrued interest on debt instruments.  Accrued but unpaid interest is included in the FMV of bonds at death for ErbSt purposes and is then taxed as investment income when ultimately paid to the beneficiary.

 

In both instances, § 35b of the EStG allows a (rather stingy) bit of income tax relief for inheritance taxes paid on such "latent income" within 4 years prior to the income tax year.

 

So, what about an inherited IRA/401(k)?

 

First of all you will be subject to inheritance tax on the total fair market value of the inherited IRA.  Pretty simple:  date of death value x EUR/USD exchange rate:  € tax value less Freibetrag, etc.

 

The next step is figuring out the income taxation of distributions.

This will require you to figure out how IRA distributions would be income taxed from your own IRA as opposed to an inherited IRA.

 

According to the most recent  (9 Aug 2018) court decision (FG Köln 11 K 2738/14) which is currently pending on appeal to the German Supreme Financial Court (BFH Bundesfinanzhof, X R 29/18), the general rule will be that a ratable portion of contributions made to the IRA that did not enjoy GERMAN (as opposed to US) tax relief in the year made will be treated as tax-free when distributed in a form other than as a "Leibrente".  (§ 22 Nr. 5 Satz 2 c read in conjunction with § 20 Abs. 1 Nr. 6) 

 

 

The formula for computing the tax-free portion (i.e. the allocable portion of total contributions made) of each distribution is set forth in BMF Schreiben BMF v. 22.12.2005 - IV C 1 - S 2252 - 343/05 Rz. 61.

 

My translation and paraphrase:

 

Distribution amount times (the total of IRA/Roth/401(k) contributions made less: contributions previously recovered) divided by the FMV of the IRA at time of distribution

 

Example (assumes no contributions enjoyed German tax-free treatment when made and the decision of the FG Köln referenced above survives appeal to the BFH):

 

Distribution in 2019:    € 10,000

Total contributions:  € 15,000  (Euro values computed at rate applicable when contribution made (!!!)

Contributions recovered in prior year(s): €1,000

FMV of IRA immediately prior to distribution:   €50,000

 

10,000 x (15,000 - 1,000)/50,000 = €2,800 tax free portion of this distribution  €7,200 will be subject to Abgeltungssteuer 26.375%

 

(NB:  there might be some minor relief based on § 35b of the EStG if any inheritance taxes were paid on the IRA within 4 years of the income tax year in question.)

 

The apparent alternative to this is to "annuitize" the IRA. This means entering into a contract that provides for you to use the IRA value to purchase a life-long annuity. Assuming this is recognized as a "Leibrente" the income portion will be computed and taxed as provided under § 22 EStG. Although this could create US tax planning problems - not to mention financial disadvantages - it does make the computation of German income pretty easy; you don't need to know the amount of contributions.

 

So, what about the tax treatment if you INHERITED the IRA instead of paying into it yourself?

 

My (educated) guess based on application of the fundamental principle of German inheritance law is that the IRA will be treated as a capital asset other than an insurance policy.  In other words, the decedent's contributions will "carry over" and be treated as the beneficiary's contributions; just like the purchase of shares of stock.

 

And, like shares of stock, the total FMV of the IRA will be subject to German inheritance tax when received and then each subsequent distribution will be income taxed according to the formula set forth above.

The nasty part, of course, will be substantiating the US decedent's contributions and converting them to their Euro value when made.  If the IRA was a rollover from a 401(k) the employer's contributions will need to be substantiated and/or if the IRA was a rollover from a spousal IRA the predeceased's spouse's contributions will have to be substantiated as well - and that predeceased's spouse's employer's contributions if it was originally a 401(k).

 

Again, the option of annuitization will likely be available here, too.  But that is fraught with problems of its own.

 

So . . . if you think you're going to be an IRA beneficiary in Germany you may want to communicate with your benefactor-to-be and tell him or her the problem you will face.

 

Please do not take the above as anything more than an educated guess.

 

As noted, the issue of recoverability of contributions that were not German tax-advantaged when made is being appealed (by the FA) to the BFH and the answer above assumes that the appeal will fail.

 

And don't for a moment think that your local neighborhood Steuerberater or Finanzbeamter is going to understand a word of this.

 

You're gonna have to rub their noses in the cited cases, OFD KA

Merkblatt and BMF Schreiben and then you will have to persuade them to read it.

 

Good luck with that.

 

 

 

 

 

 

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Hi @straightpoop, hope you are well.

 

> The next step is figuring out the income taxation of distributions.

> This will require you to figure out how IRA distributions would be income taxed from your own IRA as opposed to an inherited IRA.

>

> According to the most recent  (9 Aug 2018) court decision (FG Köln 11 K 2738/14) which is currently pending on appeal to the German Supreme Financial Court (BFH

> Bundesfinanzhof, X R 29/18), the general rule will be that a ratable portion of contributions made to the IRA that did not enjoy GERMAN (as opposed to US) tax relief in the year

> made will be treated as tax-free when distributed in a form other than as a "Leibrente".  (§ 22 Nr. 5 Satz 2 c read in conjunction with § 20 Abs. 1 Nr. 6) 

 

So, just so I'm clear... when you say "contributions made to the IRA that did not enjoy German tax relief"... so are you saying that if you contributed pretax dollars to an IRA for 20 years in the US... move to Germany... contribute more while a resident of Germany (with US/German tax relief)... that when the money is distributed for the first time, if you are still a resident of Germany, you calculate how much tax in Germany to pay based on:

 

D - contributions while living in Germany, free of US/Germany taxation at the time

U - contributions while living in the US, free of US/Germany taxation at the time

T - Total account value when taking first distribution

G - gain (T - D - U)

 

Distribution X ((D+G)/T) = investment income to be taxed in Germany that year?

 

Thanks.

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I read a very interesting article on avoiding US probate court for real estate in certain US states by setting up a so-called "Ladybird Deed" . This has the effect effect of transferring the US real estate to the heir on the owner's death without requiring a will and probate court process (which would take a year or two).

 

So far, so good.

Would this also solve the German inheritance tax problem on US real estate if the owner is resident in Germany for more than ten years? It seems EU law was changed some years ago to tax the entire inheritance according to the laws of the country of residence (didn't use to be that way, US real estate used to be be covered by US state inheritance law).

I think it would, as the property basically already was deeded to the heir.

 

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13 hours ago, StephenGermany said:

So, just so I'm clear... when you say "contributions made to the IRA that did not enjoy German tax relief"... so are you saying that if you contributed pretax dollars to an IRA for 20 years in the US... move to Germany... contribute more while a resident of Germany (with US/German tax relief)... that when the money is distributed for the first time, if you are still a resident of Germany, you calculate how much tax in Germany to pay based on:

 

D - contributions while living in Germany, free of US/Germany taxation at the time

U - contributions while living in the US, free of US/Germany taxation at the time

T - Total account value when taking first distribution

G - gain (T - D - U)

 

Distribution X ((D+G)/T) = investment income to be taxed in Germany that year?

 

 

You appear to understand the basics but I'm afraid I don't understand your formula. "Gain" is a misleading term and plays no role in the formula. Nor is the formula's validity limited to a "first distribution". The formula is designed to compute the total amount of basis recovered in any given distribution. Some of that basis may be a) tax-free because it is allocable to contributions made from after-(German)tax income or b ) taxable because it is allocable to contributions that received favorable German income tax treatment when made.

 

The example I provided assumes that none of 15,000 in total contributions were German tax-advantaged when made.

 

According to the OFD KA, when an IRA distribution is received that represents (previously deferred) deferred income from both after tax and pretax (deferred) income there has to be an allocation so that the tax-advantaged contributions do not permanenty escape taxation when the distribution is taken. The OFD KA refers to BMF Schreiben v. 11.11.2004 - IV C 3 - S 2257 b - 47/04 BStBl 2004 I S. 1061 for the formula for making such allocation.

 

The BMF formula, in turn, uses a brutally simple ratio of the tax-free contributions / total contributions In other words, it makes no effort to weight the contributions according to the time they were made and thus allow for their varying degree of income producing productivity within the IRA account.  The BMF Schreiben also acknowledges that this lack of sophistication might produce untoward results - in one direction or the other - that it might be willing to correct if the occasion warrants.

 

Returning to the example I gave in my earlier post:

 

If 5,000 of the total of 15,000 in contributions to the IRA were made German "tax-deferred" then 1/3 of the total contributions recovered (2,800/3 = 933.33) in this distribution would be taxable income upon distribution.

 

The taxpayer would report a taxable IRA distribution of 8,133 (10,000 - (2/3 of 2,800))

 

Immediately after this distribution the IRA in the example would have been worth € 40,000.  Assume that over the next time period before the next distribution - this time only € 8,000 - a combination of exchange rate changes and income added € 2,000 to that value.  The formula would result in the following:

 

8,000 (distribution) x (15,000 total contributions - 2,800 contributions previously recovered)

42,000 (FMV/Zeitwert immediately before distribution)

 

The result would be a recovery of  2,323.89 of total contributions, of which 774.60 would be taxable (5000/15000 = 1/3) and 1,549.28 would represent a non-taxable distribution of previously taxed income.  The taxpayer would report taxable (Abgeltungssteuer) income of 6,450.72 on his € 8,000 IRA distribution.

 

This exercise would then be repeated every year until all contributions had been recovered after which point all distributions would be 100% taxable.  The rate at which the contributions are recovered will be determined in large part by the performance of the assets remaining in the IRA.

 

 

 

 

 

 

 

 

According

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10 hours ago, Metall said:

I read a very interesting article on avoiding US probate court for real estate in certain US states by setting up a so-called "Ladybird Deed" . This has the effect effect of transferring the US real estate to the heir on the owner's death without requiring a will and probate court process (which would take a year or two).

 

So far, so good.

Would this also solve the German inheritance tax problem on US real estate if the owner is resident in Germany for more than ten years? It seems EU law was changed some years ago to tax the entire inheritance according to the laws of the country of residence (didn't use to be that way, US real estate used to be be covered by US state inheritance law).

I think it would, as the property basically already was deeded to the heir.

 

@Metall

 

Other than perhaps timing, the manner in which real property is transferred to a beneficiary is irrelevant for German inheritance taxes (same for US Federal estate taxes). It doesn't matter if it descended immediately on death (the rule in most states), is distributed as a probate asset or trust asset, or by a transfer on death deed (similar to a ladybird deed and now available in many states).

 

The change in EU law you refer to had nothing to do with taxes - at least not directly.  Rather, it relates to the law applicable to succession to decedents' estates. In other words it dealt with the determination of which country's law determines who gets what rather than who pays how much taxes to whom and why (although, obviously, who gets what will ultimately be significant in determining who pays how much).

 

US real estate remains covered by US state inheritance law regardless of any change in EU choice of law rules.

 

If a US citizen dies domiciled in Germany his worldwide estate will be subject to German inheritance tax regardless of the 10-year rule contained in the US-German estate tax treaty.  However, under the treaty any real estate located in the US will not be taxable by Germany - unless it goes to a German resident - if the US citizen decedent has not been domiciled in Germany at least 10 years.  A Germany resident beneficiary of a gift of US real estate can claim a credit on their German inheritance/gift tax for whatever Federal and state death taxes were paid on the US real estate.

 

 

 

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Thanks, @Straightpoop. I think I originally read your post incorrectly. I thought you were saying that contributions that were made while living in the US (i.e. nothing to do with Germany) would be Germany tax free for distributions (the principal portion of the distribution) made while living in Germany. That's why my formula made a distinction between contributions made in the US vs Germany. But what you really said, is that if you contributed post-tax money to a retirement account, i.e. taxed by Germany already, then these funds can be taken out tax-free, which of course is logical. But that should apply to funds already taxed by the US as well, right? So for a Roth (let's ignore for now whether Germany recognizes Roth accounts as retirement accounts, or treats them as brokerage accounts, and assume they are retirement accounts), or an IRA that was funded in the US with post-tax money, when distributions are made from that account, Germany would also not tax the portion of the distribution which is principal, if it were previously taxed by the US, right? So it's basically the same in Germany as in the US. When you take money out of a retirement account, you only pay income taxes on the portion of the distribution which was not previously taxed. Right? Of course distributions are always considered to be part principal, part gain/profit, matching the state of the IRA at the time of the distribution. Thank you!

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4 hours ago, Straightpoop said:

 

Other than perhaps timing, the manner in which real property is transferred to a beneficiary is irrelevant for German inheritance taxes (same for US Federal estate taxes). It doesn't matter if it descended immediately on death (the rule in most states), is distributed as a probate asset or trust asset, or by a transfer on death deed (similar to a ladybird deed and now available in many states).

 

So what if the heir is added as a co-owner to the US real estate? That is is a potentially taxable gift, right?

 

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@StephenGermany

 

The general principle that previously taxed funds used to purchase an investment whether it be a house, shares of stock or an IRA account will not be taxed again when that investment is sold or, in the case of an IRA, withdrawn is as good in Germany as it is in the USA.

 

The corollary that pre-tax funds will be taxed when distributed is also chiseled in stone in both countries.

 

But in the Köln case I referred to the FA is arguing that because an IRA contribution "coulda, woulda, shoulda" been tax advantaged in Germany if the taxpayer were resident in Germany and otherwise making a treaty-qualified contribution to an IRA, then Germany should treat the distributions from that IRA as if  they were derived exclusively from German tax-advantaged contributions. In other words as if the contributions were made from German earnings to a US plan that he had established before coming to Germany and he had actually claimed and received the benefit of tax deferral under § 3 Nr. 63 of the EStG.

 

The FG Köln told the FA they were flat wrong and that their position had zero support in the plain language of § 22 EStG. Moreover the FB wasn't persuaded by the FA's contorted interpretation of Art 18A of the DBA-USA which they - correctly - observed was utterly inapplicable to the situation.

 

Here is the fact situation before the FG Köln (and now before the BFH):

 

Note:  the case is an example of how the treaty can sometimes (albeit rarely) result in double non-taxation.

 

German citizen gets sent to work in the US in 2005.  Abandons his German tax residency for the period he is in the USA and in May 2011 returns to Germany and resumes German tax residency.

 

From 2006 to 2011 he is enrolled in and contributes to his employer's 401(k).  US tax law allows US income tax deferral on the contributions made by himself and employer.


In 2011, after abandoning US tax residence and resuming German residence he closes his 401(k) and takes a full distribution. 

 

He computes his German tax as I described in my earlier Email with the result that he actually had a loss, i.e. his distributions less the contributions was negative. (Obviously the employer's 401(k) was not that hot and/or got severely hammered in the financial crisis.)

 

Because of his German residence at the time of the distribution in 2011, the US permanently loses the right under the DBA-USA to tax the contributions that were used to reduce his taxable income while he was working and tax-resident in the USA.  And now, relying on the plain language of § 22 Nr. 5 Satz 1, the taxpayer argues - correctly and successfully - that Germany may not tax those contributions either.

 

Result:  double non-taxation.

 

(By the way, the US has been making noises for years about this rather common state of affairs and has threatened to amend the treaty to allow them to impose a minimum withholding tax on 401(k), IRA distributions in these circumstances.  They still haven't done anything though.)

 

Anyway, the FA is arguing that because the new Art. 18A of the treaty was in effect as of 1 Jan 2008 all his US pre-tax contributions made after that date should be deemed tax-advantaged under German law - even though he was not a tax resident of Germany at the time and - obviously - could not have claimed any German tax benefits of the kind described in §22 Nr. 5 Satz 1 of the EStG.

 

As noted, the FG told the FA to take a hike but has allowed an appeal to the BFH.

 

So watch this space for further developments.

 

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I'm sorry if I'm being dense. I'm hoping a short example post will clear this up for me.

 

A US citizen (but doesn't matter), contributes $80K to an IRA while living in the US over several years. Bobby moves to

Germany and let's the IRA grow via stock appreciation and dividends. When he retires, in Germany, he takes the money out

all at once, and it's worth $200K. Are you saying he only needs to pay taxes on $120K of the distribution to Germany?

Whereas he is taxed on $200K of the money in the US (given he's a citizen, ignoring FTC for now)?

 

That's what I tried to say in my first response. That would be great, given tax rates in the US are lower... and given the FTC

accrual that could be used from past years in the capital gains & passive income buckets to offset the US taxes due.

 

Sorry if I still don't get it. =)

 

Thanks.

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4 hours ago, Metall said:

So what if the heir is added as a co-owner to the US real estate? That is is a potentially taxable gift, right?

 

Indeed it is.

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2 hours ago, StephenGermany said:

Are you saying he only needs to pay taxes on $120K of the distribution to Germany?

 

Yep. That is the current state of German law as I understand it.

 

2 hours ago, StephenGermany said:

That would be great, given tax rates in the US are lower... and given the FTC

accrual that could be used from past years in the capital gains & passive income buckets to offset the US taxes due.

 

IRA distributions fall into the "General limitation" bucket for FTC purposes. The contributions are based on income from employment and so they retain that "employment income" character for purposes of determining their FTC bucket.  This is true even though Germany taxes it as if it was "investment income" under § 20 Abs. 1 Nr. 6 of the EStG. 

 

(In contrast, a garden variety annuity that is purchased outside of an IRA or other employer pension benefit plan, however, would fall into the "passive" bucket.)

 

For FTC purposes the geographical "source" of an IRA is the country where the wages were earned upon which the contributions were based.  In your example that would be the USA.  Since the US rules for a FTC require that the income be "foreign sourced", you would have to turn to the "resourcing rules" of Art. 23 of the treaty to get around this problem. Because under the treaty Germany has the "exclusive" right to tax the IRA distributions, Art. 23 will allow you to resource 100% of the US-sourced IRA distributions and thereby make them "foreign sourced" and thus qualify the German taxes on them for the FTC.

 

 

 

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Wow. I’ve read through this twice and will certainly need to read through it again to get it to even start to sink in.  Thanks Straightpoop for taking the time to outline this but I think you are right, I will need someone other than my local Steuerberater to help - any Frankfurt based suggestions from anyone?  Also, and just as a point of clarification, I am inheriting an IRA from someone deceased so no way to change the way it is set up, distributed, etc.  Thanks again for all the input/help!

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