The following post is from a guest blogger from Greenback Tax Services.
How a Tax Treaty Can
Help You Save on US Expat Taxes
Have you
heard of US tax treaties? If not, you aren’t alone! While most expats can
offset their US tax liability using the Foreign Earned Income Exclusion, the
Foreign Tax Credit or the Foreign Housing Exclusion, sometimes there are tax
treaty benefits that can provide additional relief from US taxation. Not every
country has a treaty with the US but if you live in a country that does, you
may be able to take advantage of their tax-saving benefits!
What is a tax treaty?
Tax treaties
primary help US non-residents or dual-resident taxpayers. Under these
treaty agreements, residents of countries outside the US may be taxed at a
reduced rate, or certain income items received by these residents could be
exempt from US taxes. Unfortunately the largest amount of tax treaty
provisions do not apply to US citizens or green card holders living abroad; but
there are some exceptions. For instance, the US tax treaties with the UK and
Canada include provisions that apply to US citizens living in those countries.
Under these treaties, residents (not
necessarily citizens) of foreign countries are taxed at a reduced rate, or are
exempt from US taxes on certain items of income they receive from sources
within the United States.
As you might expect, the reduced rates and
exemptions vary by country and by type of income received. In addition,
residents or citizens of the United States are taxed at a reduced rate, or are
entirely exempt from foreign taxes, on certain items of income they receive
from sources within foreign countries, too. You’ll need to have a permanent
residence in a foreign country for many of the treaty benefits to apply.
However, most income tax treaties contain
what is known as a "saving clause" which prevents a citizen or
resident of the US from taking advantage of the provisions of a tax treaty to
avoid taxes on US income. This clause preserves the right of the country to
tax you as if no treaty existed if it appears you are trying to avoid taxation.
This is a bit confusing, so you may want to read up on the savings clause in more detail.
What is the biggest benefit of a tax
treaty?
The
prevention of dual-taxation is far and away the greatest benefit. To explain it
simply, these treaties prevent you from being taxed in the US and in your host country on the same
income.
Let’s look
at an example.
You are a US
person living in South Korea. You are employed as a teacher in an international
school. The school is not a US company, so only withholds South Korean taxes
from your income. Because you are a US person, you are required to report your
worldwide income on your US tax return each year, and subsequently pay US tax
on that income. So, on the surface, it seems as though you are being double
taxed, paying taxes to South Korea and the US on the same income. This is where
the benefit of a tax treaty comes into play. Since the US and South Korea have
a tax treaty, you are able to use the taxes that you have already paid to South
Korea on your income to offset any US taxes on the same income.
If you are a
South Korean resident, and you are sent by your employer on temporary work
assignment to the US, you can also utilize the US – South Korea tax treaty.
Your income earned while you were working in the US is only subject to tax in the
US. Your taxes paid to South Korea can be used to offset the taxes due in the
US and vice versa.
To utilize
tax treaty benefits, Form 8833 must be attached to your US expat tax return.
You simply provide an explanation of the treaty-based position you are
applying, as well as the amount of exempt income and a brief summary of the
facts upon which the treaty position is based.
Can tax treaties offset Social
Security taxes?
Yes, but
only if the foreign country in which you reside has a specific type of tax
treaty, called a Totalization Agreement. These agreements, which the US has
with 25 countries, prevent you from paying into two Social Security systems at
one time.
If you work
for a US employer, and you are relocated to South Korea for less than 5 years,
your employer will continue to withhold US social security taxes from your pay.
You will not pay social security taxes to South Korea. If you are sent for more
than 5 years, or you were originally employed in South Korea, you will pay
social security taxes to South Korea alone.
The benefit to the Totalization Agreement is that your social security
credits will count whether you are paying into the US or the South Korean
social security systems. This means that
if you choose to retire in the US after working under the South Korean social
security system, the credits you earned while abroad will be used to calculate
your total benefits in the US If you choose to retire in South Korea after
working under the US social security system, your US credits will be used to
help calculate your total benefits in South Korea.
South Korea is
not the only country the US has a Totalization Agreement with. Here are the
countries that have Totalization Agreements with the US.:
Countries
with Social Security Agreements
|
Country
|
Entry into Force
|
|
November 1, 1978
|
|
December 1, 1979
|
|
November 1, 1980
|
|
July 1, 1984
|
|
July 1, 1984
|
|
August 1, 1984
|
|
January 1, 1985
|
|
January 1, 1987
|
|
April 1, 1988
|
|
July 1, 1988
|
|
August 1, 1989
|
|
November 1, 1990
|
|
November 1, 1991
|
|
November 1, 1992
|
|
September 1, 1993
|
|
November 1, 1993
|
|
September 1, 1994
|
|
April 1, 2001
|
|
December 1, 2001
|
|
October 1, 2002
|
|
October 1, 2005
|
|
October 1, 2008
|
|
January 1, 2009
|
|
March 1, 2009
|
|
May 1, 2014
|
What if I am self-employed?
Here is more good news! Earning income as an independent contractor or as a sole
proprietor (small business owner) in one of these 25 countries exempts you from
US self-employment tax. Self-employment taxes are Social Security and Medicare
taxes on your income, and are calculated differently than income taxes. The Totalization Agreement allows you to
avoid US self-employment taxes as long as you don’t have a fixed base in
the US available to perform the services. (A fixed based means a fixed
place of business, which includes a branch, place of management, an office or a
warehouse.) So, if you are living in South Korea, you will only pay self-employment
taxes (or their equivalent) in South Korea. Remember that this doesn’t
eliminate the need to pay regular ole’ US income taxes, however!
In order to avoid paying
self-employment taxes you will need to get a certificate of coverage letter from
your local taxing agency or the US, depending upon the wording of the specific Totalization Agreement.
A certificate of coverage is generally a letter or form that certifies that you
are covered by that country’s social security system. You should only have to
request this form once for as long as you stay in the same self-employment
position, only requesting a new form if there is a break in your employment
status.
For South Korea, you would
need to request a certificate of coverage from the National Pension Service.
You will receive a form KOR-USA 4 from the National Pension Service. A copy of
this form will need to be attached to your US tax return each year you
claim an exemption from the self-employment taxes.
Tax treaties
are complicated, so we highly suggest speaking with an expat tax professional
to determine if claiming a treaty-based position will help you reduce your US
expat taxes!
This post was written by David
McKeegan, co-founder of Greenback Expat Tax Services. Greenback specializes in
the preparation of US expat taxes for
Americans living abroad. Greenback offers straightforward pricing, a simple,
hassle-free process, and CPAs and IRS Enrolled Agents who have extensive
experience in the field of expat tax preparation.
Disclaimer: