American in Germany Who Stopped Filing for 7 Years

The Client's Situation

Michael (name changed) grew up in Ohio, studied engineering at a state university, and spent his first few years out of college working at a manufacturing firm in Detroit. In 2016, a German automotive company offered him a position at their headquarters in Munich. He accepted, moved to Germany, and began a new chapter of his life abroad.

Michael filed US tax returns for 2015 (his last full year in the US) and 2016 (a split year). After that, he stopped. His reasoning was straightforward: he was paying German income tax on his salary through his employer's payroll system, and Germany's tax rates were significantly higher than what he had paid in the US. He assumed that paying taxes in the country where he lived and worked was sufficient, and that filing a US return on income earned entirely in Germany was unnecessary.

This is one of the most common misconceptions among American expats. It is also completely wrong.

By the time Michael contacted Qorri Tax in late 2023, he had seven years of unfiled US tax returns. He had also accumulated a substantial financial footprint in Germany:

• A checking account (Girokonto) at Deutsche Bank with approximately EUR 45,000
• An employer pension (Betriebliche Altersvorsorge) with approximately EUR 85,000 in accumulated value
• A brokerage account with approximately EUR 30,000 in German-domiciled ETFs and individual German stocks
• A savings account (Tagesgeldkonto) with approximately EUR 12,000
• Annual German-source salary ranging from approximately EUR 95,000 to EUR 120,000 over the seven-year period

Michael had never heard of the FBAR. He had never filed Form 8938. And he was completely unaware that his German ETFs qualified as PFICs under US tax law.

What finally prompted him to seek help was a conversation with another American expat at a work event in Munich. The colleague casually mentioned that she still filed US taxes every year, and Michael realized, with growing alarm, that he might have a serious problem.

Why This Was a Serious Problem

On paper, Michael's situation looked dire. Seven years of unfiled returns, seven years of missed FBARs, unreported foreign financial accounts, PFICs, and a German employer pension with complex US tax treatment. The potential penalties, if the IRS had initiated enforcement, were substantial.

Failure-to-File Penalties

The penalty for failing to file a US tax return is 5% of the unpaid tax for each month or partial month the return is late, up to a maximum of 25% of the unpaid tax. For seven years of unfiled returns, this could have been significant if any US tax was actually owed.

FBAR Penalties

With aggregate foreign account balances consistently exceeding $10,000 (his German accounts alone totaled well over EUR 170,000), Michael should have been filing FBARs every year. Non-willful FBAR penalties can reach $10,000 per account per year. With four to five reportable accounts across seven years, the theoretical maximum exposure exceeded $250,000.

German ETFs as PFICs

Michael's German brokerage account held several German-domiciled ETFs. These included funds tracking the DAX, a European equity index fund, and an emerging markets fund. All were domiciled in Germany or Luxembourg and all qualified as PFICs. Each one required Form 8621, none of which had been filed.

It is important to note that the PFIC classification depends on the fund's domicile, not what it invests in. A German-domiciled ETF tracking the S&P 500 is still a PFIC. The only way to avoid PFIC treatment is to invest through US-domiciled funds.

German Employer Pension

The Betriebliche Altersvorsorge (bAV), or company pension, is a standard employee benefit in Germany. Employer contributions go into a pension fund, and the accumulated value grows tax-deferred. Under German tax law, contributions may be partially or fully tax-exempt, and taxation occurs upon distribution in retirement.

Under US tax law, the treatment is more complicated. The US-Germany tax treaty (Article 18A) provides some relief for qualified pension plans, but the analysis requires determining whether the German pension qualifies under the treaty provisions and whether the proper elections have been made. Without proper treaty elections, employer contributions could be treated as current taxable income, and the growth within the pension could lose its tax-deferred status for US purposes.

The Silver Lining

Despite the seemingly overwhelming list of compliance failures, there was very good news. Because Michael had lived in Germany continuously since 2016 and easily met the physical presence test (330+ full days outside the United States in the relevant tax years), he qualified for the Streamlined Foreign Offshore Procedures (SFOP). And unlike its domestic counterpart (SDOP), SFOP carries absolutely zero offshore penalty.

The Approach: Streamlined Foreign Offshore Procedures

The Streamlined Foreign Offshore Procedures is designed specifically for taxpayers like Michael: US citizens or permanent residents living abroad who non-willfully failed to file returns and report foreign accounts. The program requires filing three years of delinquent tax returns (not seven, just the most recent three) and six years of delinquent FBARs.

Our approach proceeded through several interconnected steps, each carefully designed to minimize Michael's tax liability while achieving full compliance.

Step 1: Gathering German Financial Documentation

We worked with Michael to obtain comprehensive documentation from his German financial institutions. This included annual Jahressteuerbescheinigungen (annual tax certificates) from Deutsche Bank and his brokerage, which detail interest earned, dividends received, and capital gains realized. We also obtained his Lohnsteuerbescheinigungen (wage tax certificates) from his employer for each year, showing gross salary, social contributions, and German income tax withheld (Lohnsteuer, Solidaritatszuschlag, and Kirchensteuer).

For the employer pension, we obtained annual statements showing employer contributions, employee contributions (if any), and the accumulated balance. We also reviewed the pension plan documents to determine its structure for treaty analysis.

Step 2: Optimizing the FEIE and FTC Combination

This was the most critical step in eliminating Michael's US tax liability. Two provisions of the Internal Revenue Code work together to protect American expats in high-tax countries from double taxation.

The Foreign Earned Income Exclusion (FEIE), IRC Section 911: This provision allows qualifying US citizens and residents living abroad to exclude a set amount of foreign earned income from US taxation. The annual exclusion amount is adjusted for inflation. During the years covered by Michael's filing, the limits ranged from approximately $101,300 (2016) to approximately $120,000 (2023). To qualify, Michael needed to meet either the bona fide residence test or the physical presence test. Having lived and worked in Munich continuously, he easily met the physical presence test (330+ full days outside the US in each 12-month period).

For each year, the FEIE excluded the first $100,000 to $120,000 of Michael's salary. But his salary ranged from EUR 95,000 to EUR 120,000 (approximately $105,000 to $140,000 at prevailing exchange rates). In the later years, his income exceeded the FEIE limit.

Foreign Tax Credits (FTC), IRC Section 901: For income above the FEIE limit, Michael could claim dollar-for-dollar credits for German income tax paid on that income. Germany's marginal tax rate on income above EUR 58,000 is 42%, plus a 5.5% solidarity surcharge, bringing the effective marginal rate to approximately 44.3%. This far exceeds the US marginal rate on equivalent income levels.

The result of combining FEIE and FTC was powerful. The FEIE excluded the bulk of Michael's income from US taxation. For the remainder, German tax rates exceeded US rates, meaning the foreign tax credits fully covered (and in fact exceeded) any US tax that would otherwise be due. The net US tax liability for each of the three filed years was zero.

Step 3: Three Years of Delinquent Returns

Because Michael had never filed for the covered years, these were original returns, not amendments. For each year, we prepared Form 1040 with:

• Form 2555 claiming the Foreign Earned Income Exclusion and the Foreign Housing Exclusion
• Form 1116 claiming Foreign Tax Credits for German income tax on income above the FEIE limit
• Schedule B reporting interest from German bank accounts
• Form 8938 (Statement of Specified Foreign Financial Assets) reporting all German accounts and the pension
• Form 8621 for each German-domiciled ETF
• Proper treaty-based position for the employer pension, documented with Form 8833 (Treaty-Based Return Position Disclosure)

Step 4: Treaty Treatment of the German Pension

The US-Germany tax treaty provides important relief for employer pension plans. Under Article 18A, contributions by an employer to a qualified pension plan in Germany may be excluded from the employee's gross income for US tax purposes, provided certain conditions are met. We analyzed Michael's Betriebliche Altersvorsorge and determined that it qualified under the treaty provisions.

We prepared Form 8833 for each tax year to disclose the treaty-based position, documenting that employer contributions to the pension were excludable from gross income and that the pension's investment growth maintained its tax-deferred status under the treaty. This prevented the pension from creating any current US tax liability.

Step 5: Handling the German ETFs (PFICs)

Michael's German-domiciled ETFs were PFICs, requiring Form 8621 for each one. We analyzed each fund to determine the appropriate reporting method.

As with Indian mutual funds, the Qualified Electing Fund (QEF) method was generally not available because German-domiciled ETFs typically do not provide the PFIC Annual Information Statement required for the election. However, some of Michael's ETFs were listed on exchanges recognized by the IRS, making the Mark-to-Market election potentially available for future years.

For the delinquent years, we used the excess distribution method. The good news was that the PFIC tax impact was relatively modest. The excess distribution calculations produced additional tax and interest charges, but these were largely offset by the excess foreign tax credits available from Germany's high tax rates. Because German taxes on investment income (the Abgeltungsteuer, or flat tax on capital income, at 25% plus solidarity surcharge) had already been paid, the foreign tax credits available against the PFIC tax significantly reduced the net impact.

Step 6: Six Years of Delinquent FBARs

We prepared and filed six years of delinquent FBARs through the BSA E-Filing System, reporting all of Michael's German financial accounts: the Deutsche Bank Girokonto, the Tagesgeldkonto, the brokerage account, and the employer pension (to the extent it constituted a "financial account" for FBAR purposes). Each account required the maximum balance during the calendar year, converted to US dollars at the Treasury Department's year-end exchange rates.

Step 7: Non-Willfulness Certification

The non-willfulness statement for SFOP cases involving long-term expats typically follows a clear narrative. Michael genuinely believed that paying German taxes satisfied his tax obligations worldwide. He was not trying to hide income or evade taxes. He had no US-source income, no US financial accounts of significance, and no reason to believe the IRS had any interest in his German salary.

We drafted a detailed statement documenting Michael's reliance on the common (but incorrect) belief that living and paying taxes abroad eliminated the US filing requirement. We noted that he had filed returns for 2015 and 2016 (demonstrating a history of compliance), that he had no US-source income during the non-filing years, and that he had made no effort to conceal his identity, income, or accounts from the IRS. His non-compliance was a result of misunderstanding, not intent.

The Resolution

The financial outcome could hardly have been better:

Here is the breakdown of why the outcome was so favorable:

• Zero offshore penalty under SFOP. Because Michael met the non-residency requirement (330+ days outside the US), SFOP's zero-penalty provision applied. This alone saved him from potential FBAR penalties exceeding $250,000.
• Zero additional US tax owed. The Foreign Earned Income Exclusion covered the majority of his salary. Foreign Tax Credits for German income tax covered the remainder. Germany's high tax rates meant that Michael had already paid more in tax to Germany than he would ever owe to the US on the same income.
• German ETFs reported as PFICs but generating minimal additional tax due to the FTC offset from German capital gains taxes already paid.
• No failure-to-file penalties assessed. The Streamlined procedures protect compliant filers from these penalties when the delinquent returns show no tax due.

The Outcome

Michael's total out-of-pocket cost to resolve seven years of non-compliance was limited to professional fees. He paid zero dollars to the IRS in penalties or additional tax.

Beyond resolving the past, we established a comprehensive forward-looking compliance plan:

• Annual US tax return filing with FEIE, FTC, and proper treaty elections
• Annual FBAR filing for all German financial accounts
• Annual Form 8938 reporting all specified foreign financial assets
• Investment restructuring: Michael transitioned his German brokerage holdings from German-domiciled ETFs to US-domiciled ETFs (available through international brokers like Interactive Brokers), eliminating the PFIC issue entirely going forward
• Pension treaty elections properly documented with annual Form 8833 filings
• Individual German stocks retained (not PFICs, since individual equities are not pooled investment vehicles)

The entire process, from initial consultation to IRS submission, took approximately five months. The most time-consuming element was gathering and converting seven years of German financial documentation and reconciling German tax year data (which follows the calendar year, aligning with the US tax year) with the required US forms.

Key Takeaways

Related Resources

• Streamlined Filing Compliance Procedures Overview
• SFOP Guide: Step-by-Step
• Expat Tax Services
• Form 8621 (PFIC) Filing Help
• FBAR Filing Assistance
• What to Do If You Stopped Filing US Taxes Abroad
• More Case Studies