9. Tax Treaty Benefits

Introduction

If you are a nonresident alien from a country with which the United States has an income tax treaty, you may qualify for certain benefits. Most treaties require that the alien be a resident of the treaty country to qualify. However, some treaties require that the alien be a national or a citizen of the treaty country.

See Table 9-1 for a list of tax treaty countries.

You can generally arrange to have withholding tax reduced or eliminated on wages and other income that are eligible for tax treaty benefits. See Income Entitled to Tax Treaty Benefits in chapter 8.

Topics This chapter discusses:

• Typical tax treaty benefits,
• How to obtain copies of tax treaties, and
• How to claim tax treaty benefits on your tax return.

Useful Items You may want to see:

Publication

• 901   U.S. Tax Treaties

Form (and Instructions)

• 1040NR   U.S. Nonresident Alien Income Tax Return
• 1040NR-EZ   U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents
• 8833   Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)

See chapter 12 for information about getting these publications and forms.

Treaty Income

A nonresident alien's treaty income is the gross income on which the tax is limited by a tax treaty. Treaty income includes, for example, dividends from sources in the United States that are subject to tax at a tax treaty rate not to exceed 15%. Nontreaty income is the gross income of a nonresident alien on which the tax is not limited by a tax treaty.

Figure the tax on treaty income on each separate item of income at the reduced rate that applies to that item under the treaty.

To determine tax on nontreaty income, figure the tax at either the flat 30% rate or the graduated rate, depending upon whether or not the income is effectively connected with your trade or business in the United States.

Your tax liability is the sum of the tax on treaty income plus the tax on nontreaty income, but cannot be more than the tax liability figured as if the tax treaty had not come into effect.

Example.   Arthur Banks is a nonresident alien who is single and a resident of a foreign country that has a tax treaty with the United States. He received gross income of $25,500 during the tax year from sources within the United States, consisting of the following items:

Dividends on which the tax is limited to a 15% rate by the tax treaty	$1,400
Compensation for personal services on which the tax is not limited by the tax treaty	24,100
Total gross income	$25,500

Arthur was engaged in business in the United States during the tax year. His dividends are not effectively connected with that business. He has no deductions other than his own personal exemption.

His tax liability, figured as though the tax treaty had not come into effect, is $3,304, determined as follows:

Total compensation	$24,100
Less: Personal exemption	2,900
Taxable income	$21,200
Tax determined by graduated rate ( Tax Table column for single taxpayers)	$2,884
Plus: Tax on gross dividends ($1,400 × 30%)	420
Tax determined as though treaty had not come into effect	$3,304

Arthur's tax liability, figured by taking into account the reduced rate on dividend income as provided by the tax treaty, is $3,094, determined as follows:

Tax determined by graduated rate (same as figured above)	$2,884
Plus: Tax on gross dividends ($1,400 × 15%)	210
Tax on compensation and dividends	$3,094

His tax liability, therefore, is limited to $3,094, the tax liability figured using the tax treaty rate on the dividends.

Some Typical Tax Treaty Benefits

The following paragraphs briefly explain the exemptions that are available under tax treaties for personal services income, remittances, scholarships, fellowships, and capital gain income. The conditions for claiming the exemptions vary under each tax treaty. For more information about the conditions under a particular tax treaty, see Publication 901.

Tax treaty benefits also cover income such as dividends, interest, rentals, royalties, pensions, and annuities. These types of income may be exempt from U.S. tax or may be subject to a reduced rate of tax. For more information, see Publication 901.

Personal Services

Nonresident aliens from treaty countries who are in the United States for a short stay and also meet certain other requirements may be exempt from tax on their compensation received for personal services performed in the United States. Many tax treaties require that the nonresident alien claiming this exemption be present in the United States for a total of not more than 183 days during the tax year. Other tax treaties specify different periods of maximum presence in the United States, such as 180 days or 90 days. Spending part of a day in the United States counts as a day of presence.

Tax treaties may also require that:

1. The compensation cannot be more than a specific amount (frequently $3,000), and
2. The individual have a foreign employer; that is, an individual, corporation, or entity of a foreign country.

Teachers and Professors

Nonresident alien teachers or professors who are residents of certain treaty countries and who temporarily visit the United States for the primary purpose of teaching at a university or other accredited educational institution are not subject to U.S. income tax on compensation received for teaching for the first 2 or 3 years after their arrival in the United States. Many treaties also provide exemption for engaging in research.

Generally, the teacher or professor must be in the United States primarily to teach, lecture, instruct, or engage in research. A substantial part of that person's time must be devoted to those duties. The normal duties of a teacher or professor include not only formal classroom work involving regularly scheduled lectures, demonstrations, or other student-participation activities, but also the less formal method of presenting ideas in seminars or other informal groups and in joint efforts in the laboratory.

Table of Tax Treaties

Employees of Foreign Governments

All treaties have provisions for the exemption of income earned by certain employees of foreign governments. However, a difference exists among treaties as to who qualifies for this benefit. Under many treaties, aliens admitted to the United States for permanent residence do not qualify. Under most treaties, aliens who are not nationals or subjects of the foreign country do not qualify. Employees of foreign governments should read the pertinent treaty carefully to determine whether they qualify for benefits. Chapter 10 of this publication also has information for employees of foreign governments.

Students, Apprentices, and Trainees

Students, apprentices, and trainees generally are exempt from tax on remittances (including scholarship and fellowship grants) received from abroad for study and maintenance. Also, under some treaties, a limited amount of compensation received by students, apprentices, and trainees may be exempt from tax.

Nonresident aliens who became resident aliens.   Generally, you must be a nonresident alien student, apprentice, or trainee in order to claim a tax treaty exemption for remittances from abroad (including scholarship and fellowship grants) for study and maintenance in the United States. However, if you entered the United States as a nonresident alien, but you are now a resident alien for U.S. tax purposes, the treaty exemption will continue to apply if the tax treaty has an exception to the treaty's saving clause. If you qualify under an exception to the treaty's saving clause and the payor intends to withhold U.S. income tax on the scholarship, fellowship, or other remittance, you can avoid income tax withholding by giving the payor a Form W-9 with an attachment that includes the following information.

• Your name and U.S. identification number.
• A statement that you are a resident alien and whether you are a resident alien under the green card test, the substantial presence test, or a tax treaty provision.
• Tax treaty and article number under which you are claiming a tax treaty exemption, and description of the article.
• A statement that you are relying on an exception to the saving clause of the tax treaty under which you are claiming the tax treaty exemption.

Example.   Mr. Yu, a citizen of the People's Republic of China, entered the United States as a nonresident alien student on January 1, 1997. He remained a nonresident alien through 2001 and was able to exclude his scholarship from U.S. tax in those years under Article 20 of the U.S.-China income tax treaty. On January 1, 2002, he became a resident alien under the substantial presence test because his stay in the United States exceeded 5 years. Even though Mr. Yu is now a resident alien, the provisions of Article 20 still apply because of the exception to the saving clause in paragraph 2 of the Protocol to the U.S.-China treaty dated April 30, 1984. If the payor of the scholarship intends to withhold U.S. income tax, Mr. Yu should submit Form W-9 and the required attachment to the payor.

Capital Gains

Most treaties provide for the exemption of gains from the sale or exchange of personal property. Generally, gains from the sale or exchange of real property located in the United States are taxable.

Reporting Treaty Benefits Claimed

If you claim treaty benefits that override or modify any provision of the Internal Revenue Code, and by claiming these benefits your tax is, or might be, reduced, you must attach a fully completed Form 8833 to your tax return. See Exceptions, below, for the situations where you are not required to file Form 8833.

You must file a U.S. tax return and Form 8833 if you claim the following treaty benefits.

1. A reduction or modification in the taxation of gain or loss from the disposition of a U.S. real property interest based on a treaty.
2. A change to the source of an item of income or a deduction based on a treaty.
3. A credit for a specific foreign tax for which foreign tax credit would not be allowed by the Internal Revenue Code.

You must also file Form 8833 if you receive payments or income items totaling more than $100,000 and you determine your country of residence under a treaty and not under the rules for residency discussed earlier in this publication.

These are the more common situations for which Form 8833 is required.

Exceptions.   You do not have to file Form 8833 for any of the following situations.

1. You claim a reduced rate of withholding tax under a treaty on interest, dividends, rent, royalties, or other fixed or determinable annual or periodic income ordinarily subject to the 30% rate.
2. You claim a treaty reduces or modifies the taxation of income from dependent personal services, pensions, annuities, social security and other public pensions, or income of artists, athletes, students, trainees, or teachers. This includes taxable scholarship and fellowship grants.
3. You claim a reduction or modification of taxation of income under an International Social Security Agreement or a Diplomatic or Consular Agreement.
4. You are a partner in a partnership or a beneficiary of an estate or trust and the partnership, estate, or trust reports the required information on its return.
5. The payments or items of income that are otherwise required to be disclosed total no more than $10,000.

Penalty for failure to provide required information on Form 8833.   If you are required to report the treaty benefits but do not, you may be subject to a penalty of $1,000 for each failure.

Previous | First | Next

Publication Index | 2002 Tax Help Archives | Tax Help Archives | Home