German Income Tax on VA Compensation, Military Retired Pay and Social Security

Three kinds of U.S. payment are treated three different ways by Germany, and the difference is worth real money. VA disability compensation: tax-free, and left out of the rate. Section 3 Nr. 6 of the Einkommensteuergesetz exempts payments made under statute from public funds to people injured in military service, or to their survivors, except payments granted on account of length of service. In its judgment X R 29/22 of April 23, 2026, the Bundesfinanzhof held that "from public funds" is not limited to German funds and that disability compensation paid to a former member of the U.S. armed forces for an injury suffered in service is tax-free under that section. It also held that income exempt under section 3 Nr. 6 is not subject to the progression clause in section 32b, so it does not raise the tax rate on the veteran's other German income. The tax office in that case had applied the progression clause; the court rejected it. The facts the court relied on were that the injury happened in service and the amount depended only on the degree of disability, so a payment that is in substance for length of service would not be covered. The tax treaty points the same way for war injuries. Article 19(3) of the U.S.-German income tax convention, as amended by the 2006 Protocol, exempts from tax in the other country pensions and other amounts paid by one of the countries as compensation for injury or damage sustained as a result of hostilities. Military retired pay: taxable only in the United States, unless the retiree is German. Article 19(2) makes pensions paid by a country in respect of services rendered to it taxable only in that country, unless the recipient is both a resident and a national of the other country. A U.S. retiree living in Germany owes no German tax on retired pay; a retiree who also holds German citizenship does. But under Article 23(3) Germany keeps the right to count income it exempts under the treaty when setting its rate, and section 32b(1) Nr. 3 of the Einkommensteuergesetz does exactly that for treaty-exempt income. Retired pay therefore raises the German rate on any other German-taxable income, even though it is not itself taxed. U.S. Social Security: taxable only in Germany. Article 18(5) makes social security benefits paid by one country to a resident of the other taxable only in the country of residence, treated as if they were that country's own social security. The Protocol's saving clause, in Article 1(5)(a), lists Article 18(5) among the benefits the United States gives its own citizens, so a U.S. citizen living in Germany pays tax on Social Security to Germany and not to the United States. On the U.S. side nothing else changes: retired pay stays on the U.S. return, and VA compensation stays exempt from U.S. tax under 38 U.S.C. 5301.