A tax treaty is an agreement between two countries that can help some people avoid paying taxes twice on the same income. The U.S. has tax treaties with many countries, including Australia, India, and Thailand.
Understanding what a tax treaty is and how it works can be beneficial for people who are not residents of the U.S. but who earn income from U.S. sources, as well as for some Americans who earn income in other countries.
Definition of a Tax Treaty
A tax treaty is a bilateral agreement between countries to cooperate on tax rules, which often helps workers avoid having to pay taxes on the same income to two separate countries. These rules can apply to both individuals paying personal income taxes and organizations paying business taxes.
With a relevant tax treaty in place, someone who is a resident of a country other than the United States may be able to reduce or exempt some of their income earned in the U.S. from U.S. income taxes, but they would still pay taxes to their home country. Conversely, a U.S. resident who earns income in another country may be eligible to avoid paying some taxes to that country if it has a tax treaty with the U.S.
For example, say a college professor is a resident of another country and temporarily comes to the U.S. to teach at a university. Many tax treaties include provisions that would exempt this professor from having to pay U.S. income tax on their teaching income. That way, they won’t be double taxed on that income by the U.S. as well as by their home country.
Tax treaties can also involve information sharing between two countries to help tax authorities in those nations carry out tax compliance.
How a Tax Treaty Works
A tax treaty works by establishing an agreement between two countries to help their residents avoid double taxation and to share information so that these nations can better carry out their tax laws. In many cases, tax treaties are reciprocal, meaning they work both ways for residents of both countries.
However, the specifics of the tax treaties can vary significantly depending on which countries are involved. Some treaties might exempt capital gains income from sales of real property from double taxation, whereas other treaties might exempt international students from paying U.S. income tax on the value of a scholarship.
Tax treaties can also differ in terms of how they provide benefits, which may include:
- Tax credits
- Tax exemptions
- Reduced tax rates
- Other types of benefits
Tax treaties generally apply at a federal level, although some states may follow national treaties when it comes to assessing state taxes.
What Tax Treaties Mean for Individuals
Given that many different treaties exist and the rules can vary significantly, it’s important to look at the specific agreements in place between the relevant countries that apply to your situation.
Also keep in mind that the definition of a “resident” may depend on the specific tax treaty, rather than applying across the board. In some cases, you might be a dual resident of two countries but still be able to claim some tax treaty benefits—so it’s important to check the rules of any tax treaties between countries where you live or earn income.
Claiming tax treaty benefits can also involve filling out additional tax forms. For example, a non-resident of the U.S. may have to fill out Form 8233 “to claim exemption from withholding on compensation for personal services because of an income tax treaty or the personal exemption amount.”
Again, the exact forms required depend on your situation, so you may want to consult with a relevant professional to guide you through how tax treaties affect your tax filings and overall tax management. Another option is to use tax software designed for expatriates, which is more specialized than typical tax tools.
- A tax treaty is an agreement between two countries that can help residents of one country avoid being taxed twice when they earn income in a foreign country.
- A tax treaty can also outline agreements about information sharing between two countries to help with tax compliance.
- The U.S. has tax treaties with dozens of countries, and the rules and benefits for taxpayers can vary significantly among these different agreements.