The United States has income tax treaties with a number of foreign countries. One of the primary tax treaty benefits is that they give residents of the contracting countries the security that they will not experience double taxation.
Under these tax treaties and conventions, citizens and residents of the United States who are subject to taxes imposed by the foreign countries are entitled to tax treaty benefits for certain credits, deductions, exemptions, and reductions in the rate of taxes of those foreign countries. If a foreign country with which the United States has a treaty imposes a tax on you, you may be entitled to tax treaty benefits.
Tax Treaty Benefits
While tax treaties may reduce U.S. tax for nonresidents and foreign tax for U.S. residents and citizens, each treaty must be reviewed to determine eligibility for these provisions. These treaties are stuffed with legalese and complex sections that are not user-friendly for the taxpayer. However, treaty provisions are generally reciprocal (applicable to both treaty countries) – a U.S. citizen or resident who receives income from a treaty country may also be taxed at a reduced tax rate by that foreign country. Below is a brief summary of how that works for Nonresident Aliens of the U.S. and U.S. Citizens and Residents.
For nonresident aliens, treaties limit or eliminate U.S. taxes on various types of personal services and other income, such as pensions, interest, dividends, royalties, and capital gains. Many treaties limit the number of years you can claim a treaty exemption. For students, apprentices and trainees, the limit is usually four to five years. For teachers, professors and researchers, the limit is usually two to three years. Once you reach this limit, you may no longer claim the treaty exemption. In some cases, if you exceed the limit, the income is taxed retroactively for earlier years. There may also be other requirements for tax treaty benefits.
Tax Treaty Benefits For U.S. Citizens and Residents
U.S. citizens and residents generally will not be able to reduce their U.S. tax based on treaty provisions due to the saving clause (described below). However, those who are subject to taxes imposed by a treaty partner are entitled to certain credits, deductions, exemptions and reductions in the rate of taxes paid to that foreign country. Each tax treaty must be closely reviewed to determine if the treaty benefits are applicable to U.S. citizens and resident aliens who do not reside in the U.S. Foreign taxing authorities sometimes require certification from the U.S. government that an applicant filed an income tax return as a U.S. resident, as part of the proof of entitlement to the treaty benefits
Most tax treaties have a saving clause that preserves the right of each country to tax its own residents as if no tax treaty were in effect. A saving clause preserves or “saves” the right of each country to tax its own residents as if no tax treaty existed. As a result, U.S. citizens and residents generally cannot use the treaty to reduce their U.S. tax liability.
However, most treaties provide exceptions to saving clauses that allow certain provisions of the treaty to be claimed by U.S. citizens or residents. It is important that you examine the applicable saving clause to determine if an exception may apply.
Tie Breaker Rules
Unfortunately in some cases, an individual may be in a situation where they are a resident of both countries. In which case, each treaty contains provisions on tie-breaker rules that are used to determine which country the taxpayer is to be considered a resident of for purposes of the tax treaty benefits. Some of the common provisions that are present in tax treaties include:
- The taxpayer is a resident of the country in which he or she has available a permanent home.
- If the taxpayer has a permanent home available in both countries, the taxpayer is a resident of the country in which his or her personal and economic relations are closer (center of vital interests).
- If the country in which the taxpayer’s center of vital interests cannot be determined, or if the taxpayer does not have a permanent home available to him or her in either state, the taxpayer is a resident of the country in which he or she has a habitual abode.
- If the taxpayer has a habitual abode in both countries or in neither country, the taxpayer is a resident of the country in which he or she is a citizen.
- If the taxpayer is a citizen of both countries or of neither country, the competent authorities of the two countries will settle the matter by mutual agreement.
Claiming Tax Treaty Benefits
If you claim tax treaty benefits that override or modify any provision of the Internal Revenue Code (IRC), and by claiming these benefits your tax is or might be reduced, you must attach a fully completed Form 8833, Treaty-Based Return Position Disclosure, to your tax return.
Copies of Tax Treaties
To view the text of a specific tax treaty and its tax treaty benefits, go to the IRS website and search for “tax treaties.” You will find the text of each treaty, and in most cases, the Technical Explanation for the treaty. The Technical Explanation provides more detail on the intent of the treaty language.
Our goal at Tax Samaritan is to provide the best counsel, advocacy and personal service for our clients and to ensure that all benefits such as tax treaty benefits are claimed on your tax return. We are not only tax preparation and representation experts, but strive to become valued business partners. Tax Samaritan is committed to understanding our client’s unique needs; every tax situation is different and requires a personal approach in providing realistic and effective solutions.
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Tax Samaritan is a team of Enrolled Agents with over 25 years of experience focusing on US tax preparation and representation. We maintain this tax blog where all articles are written by Enrolled Agents. Our main objective is to educate US taxpayers on their tax responsibilities and the selection of a tax professional. Our articles are also designed to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid.
When looking for a tax professional, choose carefully. We recommend that you hire a credentialed tax professional such as Tax Samaritan that is an Enrolled Agent (America’s Tax Experts). If you are a US taxpayer overseas, we further recommend that you seek a professional who is experienced in expat tax preparation, like Tax Samaritan (most tax professionals have limited to no experience with the unique tax issues of expat taxpayers).
Randall Brody is an enrolled agent, licensed by the US Department of the Treasury to represent taxpayers before the IRS for audits, collections and appeals. To attain the enrolled agent designation, candidates must demonstrate expertise in taxation, fulfill continuing education credits and adhere to a stringent code of ethics.
Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.