How to Claim Tax Treaty Benefits for U.S. Expats

The United States has income tax treaties with a number of foreign countries. One of the tax treaty’s primary benefits is that it gives contracting country residents 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 foreign countries are entitled to tax treaty benefits for certain credits, deductions, exemptions, and reductions in the rate of taxes of those foreign countries.

To use these benefits, you must have a good understanding of both U.S. and foreign tax rules. Remember, not all treaties are the same. Each one has its unique provisions. Missing these benefits could mean leaving money on the table or paying more taxes than needed. So, if you’re dealing with international taxes, it’s worth looking into how a tax treaty might work for you.

Tax Treaty Benefits

While tax treaties may reduce U.S. and foreign taxes, 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 US expats. However, treaty provisions are generally reciprocal and apply to both countries. A U.S. citizen or resident earning income from a treaty country may face a reduced tax rate in that country. Below is a brief summary of how that works for U.S. Citizens and Residents.

• U.S. Citizens and Residents

U.S. citizens and residents generally cannot reduce their U.S. tax based on treaty provisions due to the saving clause. However, if a treaty partner imposes taxes on them, they are eligible to certain credits, deductions, exemptions, and reductions in the tax rate paid to that foreign country. Each tax treaty must be closely reviewed to determine if the treaty benefits apply 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.

Saving Clause

Most tax treaties have a saving clause that preserves the right of each country to tax its residents as if no tax treaty were in effect. A saving clause preserves or “saves” the right of each country to tax its 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 U.S. citizens or residents to claim certain treaty provisions. You must examine the applicable saving clause to determine if an exception may apply.

TIP: If you can’t claim a treaty benefit due to the saving clause, you can still use the Foreign Tax Credit or Foreign Earned Income Exclusion to avoid double taxation.

Tie Breaker Rules

Unfortunately, in some cases, an individual may be in a situation where they are a resident of both countries. In such cases, each treaty includes tie-breaker rules that help determine which country considers the taxpayer a resident for 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.

Tax Treaties and State Taxes

While tax treaties can provide valuable benefits at the federal level, they do not extend to state income taxes. States have the autonomy to define taxable income. They often use federal taxable income or federal adjusted gross income as a starting point. However, each state has its own rules. Treaty benefits that apply federally may not necessarily reduce your state tax obligations.

For example, states like Alabama and California don’t honor the treaty exclusions available to students and scholars under federal law. If you claim a treaty benefit exempting a portion of your income from federal tax, you may still need to include that income on your state tax return. 

Moreover, the India-U.S. tax treaty provides a specific benefit that allows Indian students to claim the standard deduction on their federal tax returns. However, because many states calculate taxes based on federal adjusted gross income, these students might find that their treaty benefits don’t carry over to their state returns. This discrepancy can result in additional state tax liability, even with reduced or no federal tax.

TIP: Even if your state does not recognize federal tax treaties, you might still be eligible for other state-level credits or deductions that can reduce your state tax liability. Research state-specific programs or consult a tax advisor to explore potential savings.

Tax Treaties and U.S. Retirement Plans

In general, most countries do not provide special provisions in their tax treaties with the U.S. to respect the tax benefits of U.S. retirement plans such as 401(k)s or IRAs. This means that contributions, growth, and distributions from these plans may be taxed differently abroad than in the U.S. However, there are exceptions. A few countries, like the U.K. and Canada, offer specific provisions in their treaties that acknowledge U.S. retirement plans and provide some tax relief.

For example, the U.S.-Canada tax treaty allows for some cross-border tax deferral on 401(k) and IRA accounts. This means that if you’re a U.S. citizen or resident living in Canada, you may not be subject to Canadian taxes on these accounts until you start receiving distributions, similar to how the U.S. treats these accounts.

On the other hand, many other countries may not offer the same tax treatment. In these cases, contributions or earnings in U.S. retirement plans may be subject to local taxation. Additionally, distributions may face both U.S. and foreign tax liabilities.

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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. This form helps the IRS understand the treaty article you’re claiming and how it applies to your situation. It also outlines any limitations that might affect your claim.

Not every treaty claim requires Form 8833, though. For instance, if you claim a reduced withholding rate on income like interest, dividends, or royalties using Form W-8BEN, you might not need to file Form 8833. The same goes if your treaty benefits relate to income from dependent personal services, pensions, annuities, or social security. 

Form 8833 Penalties

If you fail to file Form 8833 when required, the IRS could impose a $1,000 penalty. This penalty applies for not disclosing your treaty-based return position as outlined in Section 6114. However, the IRS may waive this penalty if your failure to file was due to reasonable cause and not willful neglect.

Countries with Tax Treaties with the United States

Currently, the United States has tax treaties in effect with the following countries:

• Armenia, Australia, Austria, Azerbaijan, Bangladesh, Barbados, Belarus, Belgium, Bulgaria, Canada, China, Chile, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Georgia, Germany, Greece, Hungary, Iceland, India, Indonesia, Ireland, Israel, Italy, Jamaica, Japan, Kazakhstan, Korea (Republic of), Kyrgyzstan, Latvia, Lithuania, Luxembourg, Malta, Mexico, Moldova, Morocco, Netherlands, New Zealand, Norway, Pakistan, Philippines, Poland, Portugal, Romania, Russia, Slovak Republic, Slovenia, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Tajikistan, Thailand, Trinidad and Tobago, Tunisia, Turkey, Turkmenistan, Ukraine, the United Kingdom, Uzbekistan, and Venezuela.

Please note that the U.S. terminated its tax treaty with Hungary, effective January 1, 2024. Additionally, Chile was recently added to the list of countries with which the U.S. has a tax treaty.

To view the text of a specific tax treaty and its treaty benefits, refer to the IRS’ tax treaty page. 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.

TIP: Regularly check the IRS website or subscribe to updates, as the U.S. may sign new treaties or amendments that could benefit you. 

FAQs on Tax Treaties

1. What happens if I live in a country that does not have a tax treaty with the U.S.?

If you live in a country without a tax treaty with the U.S., you may not be eligible for the same benefits or reductions treaties provide. However, you can still claim the Foreign TaxCredit or the Foreign Earned Income Exclusion when you file. You must comply with U.S. and local tax laws without the benefit of reduced tax rates or exemptions typically provided by treaties.

2. Are tax treaties automatic, or do I need to take action to benefit from them?

Tax treaties are not automatic. You typically need to take specific actions to benefit from them. This may include completing forms like Form 8833 or Form W-8BEN or providing documentation proving your treaty benefits eligibility.

3.  Can tax treaties affect my state tax obligations?

Tax treaties usually cover federal tax obligations and don’t affect state taxes. However, some states have their own rules about international income. 

4. Can I retroactively apply for tax treaty benefits if I missed them in previous years?

You can often apply for tax treaty benefits retroactively by amending your previous tax returns. This process typically involves filing an amended return for each year you want to claim the benefits. 

5. Are there limits on how long I can claim tax treaty benefits?

Yes, many treaties impose time limits on claiming certain benefits. For example, students and trainees can usually claim benefits for four to five years. However, teachers and researchers may only have two to three years.

Get Help Claiming Your Tax Treaty Benefits

Tax treaties can help reduce taxes, but the rules can be confusing. At Tax Samaritan, we make it easy for you. Whether you need help understanding specific treaty details or want to make sure you get all the benefits you qualify for, our team is here to help.

Don’t miss out on savings or risk fines by overlooking important information. Schedule a consultation with us today!

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