A U.S. citizen moving abroad will certainly want to become familiar with the American expatriate tax benefits they may receive as a result of a tax treaty between the U.S. and their host country. The U.S. has signed tax treaty agreements with over 60 countries, with each one having its own unique and complex provisions and objectives. The primary purpose of tax treaties is to eliminate or reduce double taxation on U.S. citizens and/or green card holders living abroad who also pay the American expatriate tax. The treaties also help reduce tax evasion. This is accomplished by specifying which country will tax specific types of income, offering certain credits and/or deductions, and allowing citizens to take advantage of reduced tax rates. Each treaty has its own requirements for qualification, and will vary based on residency, nationality, and reason for travelling abroad.
Personal Services Income
Many tax treaties with the more popular countries provide for the exemption of “personal services income” from their host country’s taxation. Each treaty is different, and has its own stipulations regarding type of personal services income, length of stay in the host country, and the total amount of compensation. “Independent” personal services are those performed as an independent contractor, or self-employed individual. “Dependent” personal services are those performed for a foreign employer. The majority of tax treaties will require that the U.S. citizen not reside in the foreign country for a period exceeding 183 days. However, there are others that specify a shorter time frame. Treaties with these types of provisions include Australia, Canada, Germany, Ireland, the United Kingdom and more. For a full list of countries, and their associated provisions, refer to the IRS Publication 901 and how tax treaties will impact the American expatriate tax. There is no treaty that eliminates your need to file the American expatriate tax return.
Tax Saving Clause
While tax treaties are designed to eliminate double taxation, they are not designed to help a U.S. citizen save on their American expatriate tax when they might have otherwise had a liability. For this reason, nearly all of the tax treaties that the U.S. has negotiated include a “tax saving clause” (aka “saving clause”). This clause allows the U.S. to reserve the right to tax its citizens with the American expatriate tax as if the treaty were not in effect. This is insurance for the U.S. government that its citizens will not take advantage of a tax treaty to reduce their US expat taxes. The U.S. has made exceptions to this clause for students, teachers, researchers and trainees.
Students, Teachers Researchers & Trainees
If you travel abroad as a student, teacher, researcher, or trainee for a temporary period of time, many tax treaties will provide for the exemption of taxation in the host country. This will not protect you from the American expatriate tax, but may save on local taxes. Each treaty has its own restriction on length of time abroad, and purpose for travelling abroad. Students and trainees will be allowed to reside in a foreign country for up to four to five years, on average. Teachers and researches will usually only be allowed to be abroad for two to three years. The exemption applies to income received as a result of their student, teaching, training, or research assignment. Once you exceed the restriction on length of time abroad, you will generally be considered a resident of the foreign host country and no longer eligible for the benefits of the tax treaty.
It’s important to note that if you are relocating to a country whose tax treaty does not have a specific provision for students, teachers, researchers or trainees, there may be a personal services income (mentioned above) exclusion for which you’d qualify instead.
Dividends, Interest, and Royalties
When an investor decides to invest in foreign markets, they may be required to pay tax in the host country of the foreign corporation. As they also pay the American expatriate tax, they will be subjecting themselves to dual taxation. This is a deterrent to investing in foreign markets, and results in a barrier for international trading. As a result, most tax treaties include provisions for reduced withholding taxes on dividend, interest and royalty transactions.
Most countries have a statutory withholding rate on dividend payments, whether being paid to a resident or nonresident. Furthermore, the American expatriate tax means U.S. citizens are taxed on their worldwide income. This includes dividends and other investment income. Therefore, it’s likely that a U.S. citizen receiving foreign dividends will pay taxes to the foreign country when the dividends are distributed, and then pay taxes again to the U.S. for the American expatriate tax. However, tax treaties generally provide for a reduced statutory withholding rate on dividends paid to U.S. citizens from foreign corporations. Each tax treaty will have its own provision regarding the eligibility for the reduced withholding rate. For example, some treaties stipulate that ownership must be direct, or that the shareholder must have held the stock for a minimum length of time. Also, U.S. citizens required to pay foreign taxes on their dividends will generally be eligible to take advantage of a foreign tax credit on the American expatriate tax.
Similar to dividends, the most popular forms of interest payments also require a statutory withholding tax prior to distribution. Tax treaties between the U.S. and various other countries provide that these withholding rates be reduced. In addition, numerous tax treaties provide for the exemption of tax on interest received from various government and political organizations.
Relevant to performing artists who travel around the world to conduct work, many tax treaties will define what constitutes a royalty payment, and which withholding rates will apply. There will be various defined rates based on the type of royalty payment. For example, it is common for trademark royalties to be taxed at higher rates than patent royalties.
Absence of a Tax Treaty
If there is no tax treaty in place between the U.S. and a U.S. citizen’s host country, he or she will continue to be taxed normally by the American expatriate tax. This means that taxpayers earning higher than the amount excludable under the foreign earned income exclusion, or having a tax liability greater than the foreign tax credit will eliminate may end up being subject to dual taxation. It is important for expats to consult a tax advisor in advance of their travel to determine their ultimate American expatriate tax mpact.
Future Tax Treaties
Although the U.S. currently has existing treaties with over 60 countries, the U.S. Senate is continually working to expand this network be developing new treaties with countries. Tax treaties are intended to improve communication between countries, and reduce tax evasion practices. From beginning to end, the process for negotiating a tax treaty will take an average of five years. As the U.S. government continues to focus on international activities, the expectation is that the Senate will begin treaty negotiations with many new countries in the near future.
- IRS Publication 901: U.S. Tax Treaties
- Treasury Treaty Resource Center
- United States Income Tax Treaties – A to Z
- Claiming Tax Treaty Benefits
- Tax Treaties Can Affect Your Income Tax