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US Expatriate Tax and the Treaties That Support It

Introduction

This article is intended to offer you insight on how to fully prepare the filing of your taxes and understand your rights and responsibilities as an international taxpayer.  It has not been composed with the intention of teaching you any level of technical competence required to file your taxes completely and effectively without the assistance of a tax professional.  Hopefully, however, this article will empower you with a sufficient amount of knowledge to verify the level of competence and know-how in your chosen tax preparer.

The main reason for having a tax treaty is to be rid of double taxation on the same income in 2 different countries.  Each tax treaty is different depending on the country, and each allows for one country or the other to tax portions of your income.  Additionally, there are credits owed to you in the United States for taking part in some foreign transactions; conversely, there are penalties, as well, and a possibility to forfeit the right to claim anything at all of your foreign affairs on your expat taxes.  Knowing how each decision will impact your taxation will help you avoid unforeseen headaches in the future.

Tax Saving Clause

Tax treaties are in place to avoid double taxation; they are not in place to prevent a US citizen from being responsible for expat tax liability.  It’s important to know that almost all the tax treaties in effect have what is known as a saving clause, which reserves the right of the United States to impose an expatriate tax as if a treaty were not active.  There is an exception to the saving clause for students, teachers, researchers and trainees.

Students, Teachers, Researchers & Trainees

If you move overseas as a student, teacher, researcher, or trainee temporarily, most tax treaties will exempt you from owing taxes to your host country, but will not ‘rescue’ you from US expatriate tax liability.  While every host country has its own guidelines for the length of time you’re able to stay in these categories, there are some general averages. Teachers and researchers are limited to an average of 2 to 3 years, while students and trainees may be able to stay for as long as 4 to 5 years.

Keep in mind that not all treaties have provisions for students, teachers, researchers, and trainees; and if you are travelling abroad for this purpose in a country without such provisions, you would most likely qualify for personal services exclusion instead.

Income for Personal Services

Most tax treaties allow for an exemption of income for personal services from the host country’s tax liability.  Personal services income is for services you performed in the host country for your stateside employer; thus, your income from personal services is taxable in the United States.  Of course, every treaty carries its own definitions of personal services income and has its own set of stipulations surrounding it, including the total sum of compensation and the duration of stay in the country.  Independent services income is different than personal services income.

Independent services are much like a general contractor for which you would receive a 1099 for in the states; however, because you are generally contracting yourself to a foreign establishment, that country reserves the right to tax that income.  There are certain treaties which would grant you a deduction for paying foreign taxes, and you may seek help from a tax professional or conduct your own research to determine which.   

There are numerous treaties which stipulate that you stay in the foreign country no longer than 183 days or less, and some of these countries include:  Australia, Germany, the UK, Canada, Ireland, and more.  To conduct your own research, you can view the IRS Publication 901 and read how tax treaties will impact the American expatriate tax.  

Remember that there is not a single treaty which eliminates your requirement to file expat taxes.

Dividends, Interest & Royalties

If you are an investor who is dabbling in foreign markets, you are subjecting yourself to double taxation.  The United States seems to post a deterrent to international trade among citizens and imposes an expatriate tax on such affairs.  Additionally, you will be subject to taxation in the host country of your investment upon dividend or sale of share payout.  However, most tax treaties have some agreement in place which allows you to be charged reduced withholdings on dividends, interest, and royalty payouts.

Numerous countries have a minimum rate established for dividend payouts and interest payments, whether or not their being paid to a resident of that country.  In addition to this charge, the United States imposes expat taxes on all international income, including dividends and other income from investments. Again, however, many treaties include a provision for US citizens who are subject to expatriate taxes to take advantage of a lower statutory rate for dividend and interest payouts.   

Every tax treaty has its own rules and regulations governing the eligibility for reduced withholding rates.  For instance, a variety of treaties may have a stipulation on the directness of ownership or the length of time a stock was held.  US citizens who are subject to interest, dividend, and royalty expat taxes may qualify for a foreign tax credit on the American expatriate tax for additional savings.

An additional savings may be realized from some tax treaties in the event of interest paid from a variety of government and political organizations, such as investments in a country itself.

There are a great number of artists who travel the world for jobs, and there are quite a few treaties which have their own definition of that which indicates a royalty payment and what – if any – withholding rates will be assessed.  For instance, patent royalties are generally subject to less of a tax liability than trademark royalties.

What if there is No Tax Treaty?

In the event a tax treaty is not in place between the United States and your destination country you will be taxed normally by both parties.  While there may be numerous deductions and exclusions available to you through US expat tax laws and regulations, you may still be subject to dual taxation.  In your process of deciding where your next international destination will be, you may want to consider seeking the advice of a tax expert to help you sift through the various treaties and find the one which will offer you the most out of your expat tax return.

Future Tax Treaties

Tax treaties help to prevent tax evasion in multiple countries and opens up new lines of financial communication between countries.  Even though there are over 60 countries currently holding effective treaties with the United States, the US Senate is constantly striving to expand its tax treaty network to include more countries.  The entire process of negotiating a new treaty may take up to 5 years or more to complete, and the US Senate is expected to begin negotiating new treaties in the coming months and years.

Summarization of Treaty Articles in Comprehensible English

International Tax Treaties

The United States and a variety of other countries are involved in international income tax treaties whose terms are influenced by current worldwide models, including the OECD Model Tax Convention.  There are multiple targets and advantages to tax treaties, and the primary objective is to avoid double taxation to international taxpayers.  Here are some of the most relevant and beneficial tax treaty articles which are intended to offer US non-resident citizens and US resident aliens international tax relief:

Residence
Article IV

If an international taxpayer is decided to be a tax resident of 2 or more countries this article will refer to each country’s domestic tax laws to determine the sole entity to which taxes will be due.

Income from Real Property
Article VI

Real property is broadly defined as real estate, and part of this article relates to rental income and/or losses.  Although the country which hosts the real property is generally primarily entitled to collect taxes there is a possibility of double taxation.  In situations such as these, article XXIV (below) may limit taxation to only one country.

Dividends Article X

The flat tax rate of 30% on domestic and foreign dividends may be lowered, depending on the statutes in each country’s treaty.

Interest Article XI

The level by which your adjusted gross income is affected by interest will vary per treaty.

Gains
Article XIII

This article pertains to capital gains earned by liquidation of assets and is intended to reduce the 30% flat tax rate imposed by the US.  Quite often there is an all-inclusive provision which states that capital gains are only taxable in the taxpayer’s state of residence.

Independent Personal Services
Article XIV

This article defines each country’s right to taxation of income generated from self-employment.

Dependent Personal Services
Article XV

This article covers taxable income of international employees.  Numerous treaties indicate that if an employee’s income is paid by a country other than the US and the foreign employee resides in said country for a period longer than 183 days, his/her income can only be taxed by the state (country) in which they reside. Foreign nationals living in the US pose an exception to this rule; taxation is not imposed by the United States.

Athletes and Artists
Article XVI

This article covers many areas of artists and athletes performing in multiple countries.

Additional Income
Article XXII

This article encompasses all types of income which are not covered in other articles.

Double Taxation Elimination
Article XXIV

This article is intended to invoke the foreign tax credit, which is generally incorporated into domestic tax laws and regulations.  This article is somewhat of a default contingency to avoid double taxation when income not elsewhere covered is in question.

Exchange of Information
Article XXVII

This article allows each country’s taxation authority to exchange international taxpayers’ information.  This agreement helps to prevent tax evasion and assists with a more consistent application of domestic and international tax laws.   

Other General Facts to Consider:

  • The country which is the source of the income is generally presumed by taxpayers to retain primary taxation rights.  There are many treaties, however, which outline that income will be taxed by the taxpayer’s country of residence – despite its country of origin.  Each treaty is individual and may have very specific definitions of such income, but these treaties are still effective in avoiding double taxation.
  • There are some treaties in effect which may allow the US to tax US citizens and green card holders as if a treaty weren’t in effect – subjecting taxpayers to double taxation on certain types of income.  These various types of Savings Clauses affect different taxpayers.  You are advised to seek the advice of a tax professional to fully understand tax treaties which are in effect and how they will affect you as a taxpayer before agreeing to take an international assignment.