Tax Treaties Can Affect Your Income Tax
International Tax Gap Series
The United States has income tax treaties with a number of foreign countries. Under these treaties, residents of foreign countries are
taxed at a reduced rate or
exempt from U.S. income taxes on certain items of income received from sources within the U.S.
Because treaty provisions are generally reciprocal (apply 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.
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. This article, the ninth in a series on the International Tax Gap, provides some highlights about tax treaties and how to properly apply their provisions.
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. Thus, once you become a resident alien of the U.S., you generally lose any tax treaty benefits that relate to your U.S. income. However, many tax treaties have an exception to the saving clause that may allow you to claim certain treaty benefits even if you are a U.S. citizen or resident.
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. Treaties may also have other requirements to be eligible for benefits. Publication 901, U.S. Tax Treaties, provides a summary of these treaty provisions.
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. 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. These treaty benefits are generally only available to residents of the U.S. They generally are not available 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. Form 8802, Application for United States Residency Certification, must be filed to obtain this certification.
Disclosing Treaty Benefits Claimed
If you claim treaty benefits that override or modify any provision of the Internal Revenue Code, 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. There are exceptions to this requirement for certain types of income that are outlined in Publication 519, U.S. Tax Guide for Aliens, under the section on Reporting Treaty Benefits Claimed.
Competent Authority Assistance
If you are a U.S. citizen or resident alien, you can request assistance from the U.S. competent authority if you think that the actions of the U.S., a treaty country or both caused or will cause a tax situation not intended by the treaty between the two countries. You should read any treaty articles, including the mutual agreement procedure article, that apply in your situation. The U.S. competent authority cannot consider requests involving countries with which the U.S. does not have a treaty. See Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, and Revenue Procedure 2006-54, Procedures for How to Make a Competent Authority Request.
Obtaining Copies of Tax Treaties
To view the text of a specific tax treaty, go to irs.gov 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. You can also request the text of treaties from the Department of Treasury at the following address:
Department of Treasury
Office of Public Correspondence
1500 Pennsylvania Avenue, NW
Washington, DC 20220
Remember that treaties are updated periodically and amended by protocols, so be sure to check for the latest information on specific treaties when claiming treaty benefits.
References and Links
IRS.gov, U.S. Tax Treaties
Publication 901, U.S. Tax Treaties
Publication 519, U.S. Tax Guide for Aliens
Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad
Publication 515, Withholding of Tax on Nonresidents and Foreign Entities
Form 8833, Treaty-Based Return Position Disclosure
Form 8802, Application for United States Residency Certification
Revenue Procedure 2006-54, Procedures for How to Make a Competent Authority Request
The International Tax Gap Series