Tax Treaty Benefits
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Tax Treaty Benefits For Foreign Nationals
An income tax treaty (or convention) is an agreement between two countries under which each country agrees to limit or amend the application of its domestic tax laws for residents of the other country. Therefore, if you receive income from sources in the United States and are a resident of a country with which the U.S. has an income tax treaty in effect, you should check the provisions of the treaty to see if any of your income is exempt from U.S. tax under the treaty, or is subject to a reduced rate. A treaty provision will generally override U.S. statutory law.
Generally, all the tax treaties of which the U.S. is a party contain a "saving clause", which is meant to prevent residents of the treaty partner who are also citizens or residents of the U.S. from using the treaty to reduce their U.S. tax liability. Therefore, as a general rule, foreign nationals who qualify as U.S. residents, under either the green card test or the substantial presence test, are not eligible for treaty benefits.
However, most tax treaties contain an exception to the "saving clause" for various provisions, including the articles offering benefits for foreign nationals who are students, trainees, teachers, and researchers. Therefore, if you are no longer an exempt individual, the income you receive as an F, J, M, or Q visa holder might be exempt from U.S. taxation under the treaty with your home country, even if you are classified as a resident for U.S. tax purposes. Treaty benefits could also be available to H, O, and other visa holders who become residents for tax purposes during the first year they enter the United States.
As a resident, you will file Form 1040 and attach Form 8833 to explain the treaty benefit being claimed as well as the reliance on an exception to the saving clause. On Form 8833, check the box indicating disclosure under Section 301.7701(b) - 7 of the Treasury regulations. You are required to report worldwide income on the return but may claim the standard deduction and any other deductions and credits to which a resident alien may be entitled. If you are not e-filing, mail the return to the Department of Treasury, Internal Revenue Service, Austin TX 73301
Where to Find Treaty Information for Foreign Nationals
Here's an Overview of Tax Treaties from the IRS, with links to many IRS resources relating to treaties. To read the fill text of all tax treaties currently in effect with the United States, see United States Income Tax Treaties - A to Z.
IRS Publication 901, U.S. Tax Treaties, contains summaries of all the U.S. tax treaties in effect relating to:
- Personal service income
- Income of professors
- Teachers and researchers
- Income of students and apprentices
- Wages and pensions paid by a foreign government
A table summarizing special treaty rates for interest, dividends, pensions, annuities, social security, and royalties (Table 1) and a table recapping the various forms of service income (Table 2) can be found at Tax Treaty Tables. The Table 1 rates relate to income that is not effectively connected with a U.S. trade or business, reported on Schedule NEC page 4 of Form 1040NR.
Foreign National Treaty Examples
The following are some examples that demonstrate the procedures you should use to determine your treaty benefits from IRS Publication 901 and Tables 1 and 2 on the IRS website. First, however, here are some definitions of treaty terms:
- Independent personal services: Self-employment income
- Dependent personal services: Wages of employees
- Scholarship or fellowship: Does not include compensation for services
Sue from Belgium
Facts: Sue is a nonresident who came to the U.S. from Belgium in 2020 as an F-1 visa holder to study for her master's degree. Sue remained in the U.S. in 2021 and 2022. In 2022 she received a $6,000 scholarship from her university that pays her room and board. She was not required to perform services to receive the money. Sue also received wages as a teaching assistant of $7,500, dividend income of $50 from a U.S. corporation, and $10 in bank interest. How should Sue treat the income received for U.S. tax purposes?
Answer: First, Sue must file Form 1040NR since she is exempt from the substantial presence test in 2022 and is classified as a nonresident. Sue's dividend income is not effectively connected with Sue's U.S. trade or business, so tax on this income is computed in Schedule NEC on page 4 of Form 1040NR. Sue received Form 1042-S from the university indicating her scholarship income is taxable under Income Code 16. However, she should check Tax Treaty Table 2 on the IRS website to determine if the university is treating it correctly.
Looking at Tax Treaty Table 2, Sue finds the summary of the US/Belgium tax treaty for personal service income. Scholarship income is not listed under Income Code 16 (column 2), confirming that there is no treaty benefit for this income. However, under Income Code 20, "Compensation during study or training" is shown in column 3. This language fits Sue's wages.
The payor can be any U.S. or foreign resident (column 5), and the maximum exemption amount allowable is $9,000 p.a. (per annum) (column 6). "Maximum Presence in U.S." (column 4) says 2 years, with a reference to footnote 45. Will this deny Sue the treaty exemption? Note that footnote 45 explains that the 2-year time limit pertains only to an apprentice or business trainee, so Sue's wages will qualify for the exemption. Therefore, although Sue must include her scholarship income in her gross income, her teaching assistant wages of $7,500 are exempt from taxation under treaty article 19(1)(b) (column 7). Sue should report the treaty exempt income on page 1 of Form 1040NR, and in Item L on page 5 of Form 1040NR.
With respect to her dividend income from a U.S. corporation, Sue should look at Tax Treaty Table 1 on the IRS website, which gives tax rates on income other than personal service income. Table 1 indicates that dividends from a U.S. corporation received by a resident of Belgium are taxed at 15% (column 6)(footnotes are not relevant). Sue should report her dividends in Schedule NEC on page 4 of Form 1040NR and show that a 15% tax rate applies. Sue should also report the treaty rate on dividends in Item L on page 5 of Form 1040NR.
Bank interest is excluded from income statutorily under IRC Section 871(i)(2), and is not reported on the return.
Julie from France
Facts: Julie is a foreign national from France on a F-1 student visa, and arrived in the U.S. in 2019. In 2022 she received a $10,000 fellowship from the University of Minnesota to serve as a teaching assistant. How is her income treated on her U.S. tax return?
Answer: A look at Tax Treaty Table 2 indicates that scholarship and fellowship grants received by French residents are tax exempt for up to five years. However, because Julie is performing services for her fellowship, it does not constitute a scholarship or fellowship for tax treaty purposes. Although it's called a fellowship, Julie receives Form 10402-S from the University showing the income under Income Code 20, "compensation during study or training." Looking under Income Code 20 (column 2) in Tax Treaty Table 2, Julie finds that compensation during study or training received for up to five years from a U.S. (or other foreign) resident in the amount of $5,000 p.a. (annually) is excluded under Article 21(1). Julie should report the treaty exempt income of $5,000 as a notation on the line for treaty exempt income on page 1 and the taxable portion of $5,000 on the line for wages on page 1, Form 1040NR. The treaty exempt amount should also be reported in Item L on page 5, indicating treaty Article 21(1).
Frederick from Germany
Facts: Frederick is a foreign national visiting from Germany on a J-1 visa. Frederick came to the U.S. as a student visa holder in 2019 to study at the University of Minnesota. For 2019 and 2020, he claimed the exemption under Article 20(4) of the US/German tax treaty (Income Code 20) for compensation during study or training. In 2021, Frederick returned to Germany. He then re-entered the U.S. as a non-student J-1 visa holder to teach and do research at the University of Minnesota in 2022. He plans to stay two more years and is paid $30,000 per year. How is his income treated on his U.S. tax return?
Answer: First, as a non-student J-1 visa holder in 2022, Frederick is no longer exempt from the substantial presence test, since he was present in the U.S. as an "exempt individual" for the two of the six years prior to 2022. (See Residency Status, above.) If Frederick is present in the U.S. in 2022 long enough to pass the substantial presence test, he will qualify as either a dual status or full year resident for 2022. Looking at Tax Treaty Table 2 on the IRS website, Frederick would seem to qualify for the full exemption of his teaching/research income under Income Code 19 (column 2), Article 20(1) (an exemption for teaching generally applies to research too). Note the limit for the exemption is two years. Table 2 does not explain how his previous visit will affect his eligibility. Additionally, Table 2 does not indicate if a resident alien is eligible for the treaty exemption.
First, to address whether Frederick could claim the exemption while filing a dual status or resident tax return, we must look to the treaty itself, and amendments, to determine the scope of any exception to the "saving clause." United States Income Tax Treaties - A to Z provides access to the German treaty, which was amended by a 2006 protocol. Article 1 of the 2006 protocol provides for an exception to the saving clause for Article 20 to apply for an individual who is a resident, but neither a citizen nor a permanent resident of the United States. Therefore, if otherwise available, Frederick could claim the treaty exemption under Article 20(1) on his resident return.
Regarding the effect of his previous visit, it is helpful to read either Treaty Article 20(1) itself at US/German Tax Treaty, or IRS Publication 901 in the section for "Professors, Teachers and Researchers." Looking at the last sentence of paragraph one of Article 20, we get a clue: "The benefits provided in this paragraph shall not be granted to an individual who, during the immediately preceding period, enjoyed the benefits of paragraph 2, 3, or 4." It's not clear from this language what is meant by "immediately preceding period." More help is available in the Technical Explanation of the treaty written by the Treasury Department. This is also available at United States Income Tax Treaties - A to Z. Looking at the Technical Explanation of Article 20, paragraph 1, the Treasury writes:
"A person is not entitled to the benefits of this paragraph if he has, during the immediately preceding period, enjoyed the benefits of paragraphs 2, 3 or 4 of this Article as a student, apprentice or trainee. If, however, following the period in which a person claimed student benefits under paragraphs 2, 3, or 4, that person resumes residence and physical presence in his original home State before returning to the host State as a teacher or researcher, he may claim the benefits of paragraph 1." Therefore, since Frederick last claimed the student treaty exemption in 2020, returned to Germany in 2021 and reestablished residency, then returned to the U.S. with a non-student visa in 2022, he appears to satisfy the requirements of the treaty. Frederick would claim the exemption on his resident or dual status return using Form 8833.
Ed from Canada
Facts: Ed is a J-1 nonresident from Canada doing post-doctorate work at the University of Iowa. In 2022 he received $11,000 in wages as a teaching assistant. How is his income treated on his U.S. tax return?
Answer: Note that Tax Treaty Table 2 says that a maximum of $10,000 (column 6) of dependent personal services compensation (column 3) paid by any U.S. or foreign resident (column 5) to a Canadian resident is excluded under Article XV of the US/Canada treaty (column 7). That might imply that Ed can exclude $10,000 of his $11,000 of wages from income. However, although not evident from the table, the Treasury Department Techncial Explanation of Article XV clarifies that if the taxpayer earns more than $10,000 the total amount is taxable. Therefore, Ed cannot exclude any income under the treaty.