If you have traveled, lived, or worked in several countries, you might be able to reduce your income tax by invoking the provisions of an income tax treaty. Below 4 key benefits of tax treaties and examples on how they apply to the France-US tax treaty and to the Canada-US tax treaty.
What is an income tax treaty?
An income tax treaty is a bilateral agreement between 2 nations. The treaty provides guidelines for how taxes will be administered between the 2 nations. In general, an income tax treaty is reciprocal: the provisions apply to both nations. The US has signed more than 70 income tax treaties with other nations.
France – US tax treaty = the treaty was concluded in 1996 and amended in 2004 and 2009. In the following link the treaty text: https://www.irs.gov/businesses/international-businesses/france-tax-treaty-documents
Canada – US tax treaty = the treaty was concluded in 1985 and amended in 2007. In the following link the treaty text: https://www.irs.gov/businesses/international-businesses/canada-tax-treaty-documents
Benefit #1: Exempt Income
Under a tax treaty some categories of income may be exempt from income tax. For example, income from the social security administration or from pension may be exempt from US income tax:
France – US tax treaty = retirement income from the French social security administration is exempt from US tax.
Canada – US tax treaty = pension income that is exempt from income tax in one country is also exempt from income tax in the other country.
Benefit #2: Exempt individuals
Under a tax treaty, some categories of individuals may be exempt from income tax. For example, a teacher/researcher/student may be exempt from US tax.
France – US tax treaty = a teacher or researcher who is temporarily in the US is exempt from US tax for 2 years. Similarly, a student is exempt for 5 years for amounts up to $5000.
Canada – US tax treaty = a student who is temporarily in the US is exempt from income tax for amount from sources outside the US.
Benefit #3: Reduced tax withholding
Tax treaties ease the burden on certain tax withholding by providing for more favorable tax rates. For example, the withholding on interest and/or dividends may be limited as follows:
France – US tax treaty = the withholding tax on dividends paid in one state to a resident of another state cannot exceed 5%/10%/15%.
Canada – US tax treaty = the withholding tax on interest paid in one state to a resident of another state cannot exceed 15%.
Benefit #4: Relief from double taxation
Under a tax treaty, special foreign tax credit rules may relieve double tax on income.
For example. both the France -US tax treaty and the Canada-US tax treaty allow a tax credit for the tax paid to the other country on income from that other country.
How to claim the benefits?
To be eligible for the benefits of a tax treaty, the individual must be a citizen or a tax resident of one of the nations of the treaty.
To claim the benefits of a tax treaty the individual must hold a valid social security number (SSN) or a valid Individual taxpayer identification number (ITIN) and file the required forms (such as W8BEN, 8833 , Schedule OI) before the tax deadline.
To know more about ITIN: https://kbfinancials.biz/itin-services/
To know more about the tax deadlines: https://kbfinancials.biz/tax-calendar/
What are the limits to the benefits?
The main 3 limits of the application of a tax treaty are:
Tax treaties apply to FEDERAL tax only = the treaty does not cover state income tax. In addition, some states do not recognize tax treaties.
Tax treaties apply to INCOME tax only = the treaty does not apply to other taxes such as social security taxes, Net investment tax, value added tax.
Tax treaties are limited by the savings clause = under the “savings clause” provision , each country preserves its right to tax its citizens and resident on worldwide income as if there was no tax treaty.
Important Note: Exchange of information provision
Treaties include a provision regarding exchange of information between the 2 nations. Under this provision, each nation will exchange information with the other. So, it is important to report your income and apply the tax treaty consistently in both countries.
As always, bear in mind the date of this article as tax laws change over time.
For assistance with your international tax needs, please contact Karine Bauer, EA, JD – HERE.
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Updated July 15th, 2023