What are your tax filing obligations as an American entrepreneur in Germany?

Mike Wallace, CEO of Greenback Expat Tax Services, explains how being an American citizen with a business in Germany might affect your tax return in the US.

American citizens living abroad all have to juggle being a tax resident of one country while remaining a tax national of the US. However, American entrepreneurs have even more complexities to deal with! This article will help you understand:

• The dual tax systems
• How different German business structures can affect your US taxes
• The most important US tax forms you'll need
• Any overlooked deductions or credits that can save you money
• How to avoid the most common mistakes

Challenges faced by US expats in Germany

While taxes are complicated for most people, US citizens residing in another country often have the most complications, and they have to wrestle with them each and every year! Here are the two main causes of difficulties for Americans in Germany:

Dual tax obligations

Unlike most countries, the US taxes its citizens on their worldwide income regardless of where they live. As an American entrepreneur in Germany, you must still file an annual US tax return (Form 1040) that reports all of your income - even the income you earn in Germany.

At the same time, you will also be subject to German taxes on your business income because that's where you live and work.

Tax treaties and misconceptions

The US and Germany have a tax treaty that should prevent double taxation on the same income. However, the treaty does not exempt you from filing US taxes. There is also a “savings clause” that means the US government reserves the right to tax its citizens as if the treaty did not exist.

Make sure you are aware of the following:

• You must file a US return and use tax credits or exclusions to avoid being taxed twice.
• You must report all amounts in US dollars, using IRS-approved exchange rates. Mistakes in conversion or aligning income to the correct tax year can create problems.

Making use of totalisation agreements

Totalisation agreements are bilateral treaties between the US and other countries, including Germany, designed to prevent dual social security taxation for individuals who live and work outside of the US. Under these agreements, workers generally contribute to the social security system of only one country, avoiding double payments. 

For US entrepreneurs in Germany, the agreement clarifies whether they should pay social security (self-employment) taxes to the US or Germany. This is typically based on factors such as residency and the location of their primary business activity.

If US entrepreneurs are already paying into Germany’s social security system, a totalisation agreement will usually exempt them from paying US self-employment taxes, providing they obtain a Certificate of Coverage from German authorities as proof of their contributions. This helps minimise their overall tax burden and simplifies compliance.

German business structures and their impact on US taxes

How you set up your business in Germany can significantly impact your US tax filing requirements. The most common structures are:

1. Freiberufler (independent professional)

This set-up is for certain self-employed professions, such as consultants, artists, doctors, or engineers. By registering as a Freiberufler you will be treated as a sole proprietor for US tax purposes, meaning that you report your business income and expenses on Schedule C of your Form 1040. You may owe US self-employment tax unless you are covered by a totalisation agreement.

2. Einzelunternehmen (sole proprietorship)

An Einzelunternehmen is similar to a Freiberufler, but is often used for trade or commercial activities. You will need to report your business profits on Schedule C of your 1040, just as you would if you were a sole proprietor in the US. Bear in mind that self-employment taxes may be due in the US if you are not paying into the German social system.

3. GmbH (Gesellschaft mit beschränkter Haftung or LLC)

A GmbH is a limited liability company that is legally separate from you. These are typically considered foreign corporations for US tax purposes. You’ll likely have to file additional forms (such as Form 5471) to disclose details about the company’s income, assets, and so on. Owning more than 50 percent of a GmbH could trigger Controlled Foreign Corporation (CFC) rules, leading to immediate US tax on certain earnings.

4. UG (Unternehmergesellschaft haftungsbeschränkt)

A UG is like a “mini-GmbH”, but it has lower capital requirements (they start from as little as one euro). They are also treated as foreign corporations for US tax purposes. Ownership of a UG usually demands Form 5471 reporting, just like a GmbH.

US tax forms for self-employed Americans in Germany

There are a lot of forms in the US tax system, but don't worry - you don't have to complete them all! Here are the key forms that you are most likely to need to stay compliant:

1. Form 1040 and Schedule C

Every US citizen or resident must file Form 1040 to report their worldwide income. If you’re self-employed, include Schedule C to detail your business income and expenses. Unless you are exempt under a totalisation agreement, you’ll pay income tax and potentially self-employment tax.

2. FBAR (FinCEN Form 114)

If the total balance of all your foreign financial accounts exceeds 10.000 US dollars at any time in the year, you must file an FBAR. This is separate from your tax return and subject to strict penalties if not filed.

3. FATCA Form 8938

If your foreign financial assets are above specific thresholds (for example, more than 200.000 US dollars at year-end for single filers abroad), you must file Form 8938 alongside your 1040. This can overlap with FBAR but also includes other types of assets such as foreign stock or partnership interests.

4. Form 5471

If you own 10 percent or more of a German corporation (a GmbH or UG), you may need to file Form 5471. This form discloses the company’s income, expenses, and other financial details. Penalties for missing it are steep, starting at 10.000 US dollars per offence.

Additional Forms

You can also make use of Forms 2555 (foreign earned income exclusion) and Form 1116 (foreign tax credit) to reduce your bills - more information about these below!

Deductions and credits for US expats in Germany

Having to file taxes in two countries can cause people to worry about the amount they might have to pay. But by making use of these deductions and credit options, you can keep your bills low.

Foreign tax credit (FTC)

The Foreign Tax Credit is a dollar-for-dollar reduction of your US tax liability based on the income taxes you’ve already paid to Germany. You can claim any unused portion as a carryover, which can lower your taxes in future years if you don’t use the full credit this year. This credit often fully offsets any US taxes incurred for entrepreneurs in higher-tax countries like Germany.

Foreign earned income exclusion (FEIE)

The FEIE lets qualifying expats exclude a specific yearly amount of foreign-earned income from US federal taxation if they meet the bona-fide residence or physical presence tests. It reduces or eliminates US income tax on wages or self-employment income but does not negate self-employment taxes unless a totalisation agreement covers you. If your German taxes on that income are lower than US taxes would be, you may still benefit from combining the FEIE with other credits or deductions.

Business expense deductions

As a self-employed individual, you can subtract ordinary and necessary costs such as home office expenses, travel, office supplies, advertising and professional fees from your gross income on your US return. Keeping organised records of these expenses in both euros and US dollars is crucial for accurate filing. Even small deductions add up and can significantly reduce your overall tax burden.

Greenback Expat Tax Services specialises in helping American expats manage their US tax obligations while living abroad. Their team knows all the details of foreign business structures, tax treaties, and IRS requirements, so you don’t have to. If you'd like to discuss your specific tax situation, or just need general advice, don’t hesitate to contact Greenback Expat Tax Services.