Question

Describe the interaction between Internal Revenue Code provisions and tax treaties.'

Answer 1

The United States has income tax treaties with a number of foreign countries. Under these treaties, residents (not necessarily citizens) of foreign countries may be eligible to be taxed at a reduced rate or exempt from U.S. income taxes on certain items of income they receive from sources within the United States. These reduced rates and exemptions vary among countries and specific items of income.

If the treaty does not cover a particular kind of income, or if there is no treaty between your country and the United States, you must pay tax on the income in the same way and at the same rates shown in the instructions for Form 1040NR, U.S. Nonresident Alien Income Tax Return. Also see Publication 519, U.S. Tax Guide for Aliens, and Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.

Many of the individual states of the United States tax the income of their residents. Some states honor the provisions of U.S. tax treaties and some states do not. Therefore, you should consult the tax authorities of the state in which you live to find out if that state taxes the income of individuals and, if so, whether the tax applies to any of your income, or whether your income tax treaty applies in the state in which you live.

Tax treaties generally reduce the U.S. taxes of residents of foreign countries as determined under the applicable treaties. With certain exceptions, they do not reduce the U.S. taxes of U.S. citizens or U.S. treaty residents. U.S. citizens and U.S. treaty residents are subject to U.S. income tax on their worldwide income.

Treaty provisions generally are reciprocal (apply to both treaty countries). Therefore, a U.S. citizen or U.S. treaty resident who receives income from a treaty country and who is subject to taxes imposed by foreign countries may be entitled to certain credits, deductions, exemptions, and reductions in the rate of taxes of those foreign countries. U.S. citizens residing in a foreign country may also be entitled to benefits under that country's tax treaties with third countries.

Foreign taxing authorities sometimes require certification from the U.S. Government that an applicant filed an income tax return as a U.S. citizen or resident, as part of the proof of entitlement to the treaty benefits. For information on this, refer to Form 8802, Application for United States Residency Certification – Additional Certification Requests. In addition, refer to the discussion at Form 6166 - Certification of U.S. Tax Residency.

Note: You should carefully examine the specific treaty articles that may apply to find if you are entitled to a:

• tax credit,
• tax exemption,
• reduced rate of tax, or
• other treaty benefit or safeguard.

The Effect of Tax Treaties

Residency for treaty purposes is determined by the applicable treaty.

If you are treated as a resident of a foreign country under a tax treaty, and not treated as a resident of the United States under the treaty (i.e., not a dual resident), you are treated as a nonresident alien in figuring your U.S. income tax. For purposes other than figuring your tax, you will be treated as a U.S. resident. For example, the rules discussed here do not affect your residency time periods to determine if you are a resident alien or nonresident alien during a tax year.

If you are a resident of both the United States and another country under each country's tax laws, you are a dual resident taxpayer. If you are a dual resident taxpayer, you can still claim the benefits under an income tax treaty. The income tax treaty between the two countries must contain a provision that provides for resolution of conflicting claims of residence.

If you are a dual resident taxpayer and you claim treaty benefits as a resident of the other country, you must timely file a return (including extensions) using Form 1040NR, U.S. Nonresident Alien Income Tax Return or Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents, and compute your tax as a nonresident alien. You must also attach a fully completed Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b).