What are Tax Treaties?
The US government has income tax treaties with various foreign countries to avoid double taxation. An income tax treaty is also called a Double Tax Agreement (DTA), or a totalization agreement.
Under these treaties, residents of foreign countries can be taxed at a reduced rate or even be exempt from US income taxes on certain US income. These treaties vary between countries. If there is no treaty between your country and the US, then you’ll need to pay them regular income tax (as shown in the instructions for Form 1040NR, US Nonresident Alien Income Tax Return).
Tax treaties are only applicable to Non-Resident Aliens for tax purposes.
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Who is eligible to use tax treaties?
Generally, you need to meet the following criteria:
- You’re a resident of a country that has a tax treaty with the US
- You’re a Non-Resident Alien for tax purposes in the US
- You’re currently earning qualifying income in the US
- You have a US Social Security Number
How do I claim a tax treaty exemption?
To claim a tax treaty exemption, you’ll need to submit IRS Form 8233 to your employer prior to beginning your employment, at the start of each new tax year.
Do I need to renew a tax treaty?
After you submit your tax treaty documents for the first time, they will eventually need to be renewed. Some need to be renewed yearly, while others cover a few years and need to be renewed periodically.
When should I renew my tax treaty?
If you need to renew your tax treaty, the general window to renew your tax treaty for the next year is October 15 – December 15 of the current year. If you submit your documents after this window, you’ll still be able to claim the tax treaty, however it is not guaranteed to take effect on January 1.
The OECD Tax Treaty Model vs. UN Tax Treaty Model
Tax treaties may follow one of two models: The OECD Model or the UN Model Convention.
The OECD Tax Convention on Income and on Capital is more favorable to capital-exporting countries than capital-importing countries. Under this model, source countries are required to give up some or all of their tax on certain income earned by residents of the other country. The two countries in a treaty can benefit from this agreement if the flow of trade and investment is reasonably equal.
The UN model (formally called the United Nations Model Double Taxation Convention between Developed and Developing Countries) gives favorable taxing rights to the foreign country of investment. Typically, it benefits developing countries and gives the source country increased taxing rights over non-residents.
Can you live outside the US and collect Social Security?
Retirement pensions, 401(K)s and often Social Security benefits are incomes that remain taxable in the US as a retired expat.
Luckily, the US has tax treaties with a number of countries. This means that Americans living in these countries will only pay Social Security tax to one country, depending on how long they plan to live abroad.
Countries that the US has a totalization agreement with include:
– Australia
– Austria
– Belgium
– Brazil
– Canada
– Chile
– The Czech Republic
– Denmark
– Finland
– France
– Germany
– Greece
– Hungary
– Iceland
– Ireland
– Italy
– Japan
– Luxembourg
– The Netherlands
– Norway
– Poland
– Portugal
– The Slovak Republic
– Slovenia
– South Korea
– Spain
– Sweden
– Switzerland
– The UK
– Uruguay
Social Security is exempt from state tax when you live abroad.
What if I’m way behind on my U.S. tax returns?
There is a special IRS program to help you catch up on your U.S. taxes safely, without fines and penalties
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It’s for American citizens that didn’t know they had to file U.S. tax returns each year, and have therefore fallen behind. Some more than 30 years! With the IRS Streamlined Procedure, say goodbye to overdue tax returns, late fees, and penalties. If you have children, we can backdate your Child Tax Credit Refund for 3 years.
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Will I still have state tax filing requirements if I retire abroad?
Typically, the most likely reason for having any state tax filing requirements if you have retired abroad is from US rental properties. Retirement income and Social Security are exempt, so without any rental properties you will be fully exempt from state filing obligations. However, certain states still require filing once you’ve retired abroad, even without any state taxable income.
What is the Foreign Tax Credit?
The US’ foreign tax credit allows Americans to reduce their US tax liability on foreign income on a dollar by dollar basis.
How does Form 1118 work?
Americans living abroad also need to report their foreign registered corporations to the IRS and pay the relevant US corporation tax. This creates a risk of double corporate taxation. Filing Form 1118 fixes this by allowing Americans to claim US corporation tax credits based on the value of the foreign corporation tax they’ve already paid.
Form 1118 can be used by any corporation subject to US income tax where the same income is subject to foreign tax.
How/when do I file Form 1118?
File your Form 1118 with other corporation reporting forms from the IRS – typically Form 5471 or Form 8858 – when your corporate tax return is due.
Form 1118 takes a long time to complete, with the IRS estimating it takes around 25 hours, consisting of seven pages of schedules that request extensive details of the company and its income, foreign taxes paid, and foreign tax credit computations.
We strongly advise any expats wanting to claim corporate foreign tax credits to seek assistance from a tax specialist.
Are there penalties for not filing Form 1118? Do I have to report foreign tax paid?
No, there are no penalties for not filing Form 1118 and reporting foreign taxes you have paid – it is voluntary.
What is the foreign tax credit limitation?
Foreign tax credit can only be claimed for taxes paid to foreign countries. Taxes including the VAT (value added tax) and GST (goods and services tax) are not considered income tax.
There are certain limits to how much foreign tax a US corporation can offset. The IRS states that a corporation cannot claim a foreign tax credit that is in excess of its own corporate tax rate. For example, if Belgium’s corporate income tax rate is 33%, a US corporation with a tax rate of 20% cannot claim a credit for the 13% excess.
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