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
To find out if your country has a tax treaty with the US, the IRS has an updated listing here.
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
Italy November 1, 1978
Germany December 1, 1979
Switzerland November 1, 1980
Belgium July 1, 1984
Norway July 1, 1984
Canada August 1, 1984
United Kingdom January 1, 1985
Sweden January 1, 1987
Spain April 1, 1988
France July 1, 1988
Portugal August 1, 1989
Netherlands November 1, 1990
Austria November 1, 1991
Finland November 1, 1992
Ireland September 1, 1993
Luxembourg November 1, 1993
Greece September 1, 1994
South Korea April 1, 2001
Chile December 1, 2001
Australia October 1, 2002
Japan October 1, 2005
Denmark October 1, 2008
Czech Republic January 1, 2009
Poland March 1, 2009
Slovak Republic May 1, 2014
Source: SSA
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.
For more information about Greenback Expat Tax Services or US tax treaties, please contact us or visit www.greenbacktaxservices.com.