How the US Germany Estate Tax Treaty Works

Individuals with personal and financial ties to both the United States and Germany can face estate or inheritance taxes in both countries, creating a risk of double taxation. This occurs because each country has its own rules for taxing the worldwide assets of its citizens and residents, as well as assets located within its borders owned by non-residents. The U.S.-Germany Estate and Gift Tax Treaty is the primary tool for resolving these overlapping tax claims. This agreement provides a framework to determine which country has the primary right to tax, preventing the same assets from being fully taxed by both nations by assigning a single country of domicile and dictating how specific assets are treated.

Determining Domicile Under the Treaty

Domicile is a core concept in the U.S.-Germany Estate Tax Treaty, as it determines which country has the principal right to tax most of an individual’s estate. Domicile under the treaty is a specific legal concept distinct from mere residency or citizenship, and an individual can be a resident of one country but be domiciled in another for treaty purposes. The treaty applies to the estates of deceased persons who were domiciled in one or both countries at the time of death.

To resolve cases where an individual might be considered a domiciliary of both the U.S. and Germany under their respective domestic laws, the treaty establishes a sequence of four “tie-breaker” rules. The first rule looks to where the individual had a permanent home available. If a permanent home was available in both countries, the analysis moves to the second test: the individual’s center of vital interests, which examines where the person’s personal and economic relations were closer, considering factors like family, social ties, and business activities.

Should the center of vital interests be unclear or if the individual had no permanent home in either country, the third rule considers their habitual abode. This refers to the country where the individual spent more time. If domicile cannot be determined by habitual abode, the fourth tie-breaker rule looks to citizenship, and the person will be deemed domiciled in their country of citizenship if they were a citizen of only one.

In the rare circumstance that an individual was a citizen of both countries or of neither, and the preceding rules have not resolved the issue, the tax authorities of the United States and Germany must settle the question of domicile by mutual agreement. This collaborative process ensures that a single domicile is assigned before the treaty’s other provisions can be applied to the estate.

Treaty Rules for Taxing Specific Assets

Once domicile is established, the treaty provides specific rules that assign the primary taxing rights for different categories of assets, a concept known as “situs” or location of property. These rules determine whether the country of domicile or the country where an asset is located gets the first opportunity to tax it.

For immovable property, which includes real estate, the country where the property is physically located has the primary right to tax it. For example, a vacation home in Florida owned by a German domiciliary would be subject to U.S. estate tax first. Germany would then be required to provide a credit for the U.S. taxes paid on that property.

Business property associated with a “permanent establishment” is treated similarly. A permanent establishment is a fixed place of business, such as an office or factory, through which an enterprise is carried on. If a German domiciliary owned a business with a permanent establishment in the United States, the assets of that establishment are taxed first by the U.S. For ships and aircraft involved in international traffic, the taxing right is assigned to the country where they are registered.

The treaty’s “residuary” clause covers all other types of property not explicitly mentioned, including most intangible assets like stocks, bonds, bank accounts, and partnership interests (unless the partnership’s value is derived from immovable property). Under the treaty, these assets are taxable only by the country where the decedent was domiciled. This means if a German domiciliary holds shares in a U.S. corporation, the U.S. is prevented from applying its estate tax to those shares.

Special Deductions and Exemptions

The treaty provides for specific deductions and exemptions that can significantly reduce the tax burden, offering relief that may not be available under the domestic laws of either country. These provisions are applied after determining which country has the right to tax an asset but before the final tax liability is calculated.

One provision is the enhanced marital deduction for property passing to a surviving spouse. Under standard U.S. law, transfers to a non-citizen spouse do not qualify for the unlimited marital deduction. The treaty provides a two-part benefit: it allows an initial exclusion of 50% of the value of the U.S. property, and the estate may then take an additional marital deduction, limited to the value of the remaining qualifying property that passes to the spouse, up to the amount of the U.S. estate tax exemption.

Another benefit is the pro-rata unified credit available to the estate of a German domiciliary who owned U.S. property. Normally, the estate of a non-resident is only entitled to a minimal estate tax credit. The treaty allows for a much larger credit, calculated as a proportion of the full unified credit available to U.S. citizens.

The formula for this credit is the value of the decedent’s U.S.-situs assets covered by the treaty divided by the value of the decedent’s worldwide gross estate, multiplied by the unified credit for a U.S. citizen. For instance, if a German domiciliary had 10% of their total worldwide assets located in the U.S., their estate could claim 10% of the full U.S. unified credit.

Avoiding Double Taxation and Claiming Treaty Benefits

The primary mechanism the treaty uses to prevent double taxation is the foreign tax credit. After the rules of situs and domicile have been applied, it is possible that both countries have taxed a portion of the estate. For example, the U.S. may have taxed real estate located within its borders, while Germany, as the country of domicile, taxes the worldwide estate of the decedent. In this scenario, the country of domicile is required to grant a credit for the taxes paid to the other country on the assets it had the primary right to tax.

Germany, as the country of domicile, would provide a credit against its inheritance tax for the amount of U.S. estate tax paid on the U.S. real estate. This credit directly reduces the German tax liability, ensuring the estate does not pay tax twice on the same asset.

To secure these benefits, an estate must take specific procedural steps. In the United States, the executor must file a U.S. estate tax return, Form 706-NA. To claim a specific position based on the treaty, such as the exemption for U.S. stocks or the pro-rata unified credit, the estate must also attach Form 8833, Treaty-Based Return Position Disclosure. This form officially notifies the IRS that the taxpayer is using the treaty to alter their tax obligations, and similar disclosure requirements exist in Germany.