An income tax treaty is an agreement between two countries under which each country agrees to limit the application of its domestic tax laws for residents of the other country. Therefore, if you have come to the United States from 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.
IRS Publication 901, U.S. Tax Treaties, contains summaries of all the U.S. tax treaties in effect. It can be printed from the U.S. Treasury's Forms and Publications site. For updates from the U.S. Treasury on current treaty ratifications, see its Office of Tax Policy site. For the complete text of all tax treaties in effect with the United States go to the IRS Income Tax Treaties page.
In Publication 901, summary information on special treaty rates for dividends, capital gains, and other non-wage income is in Table 1 beginning on page 31. These rates relate to income that is not effectively connected with a U.S. trade or business, reported on page 4 of Form 1040NR. Summary information on treaty exempt wages and scholarship payments is in Table 2 beginning on page 34. More detailed information is provided for each country in the first part of Publication 901.
Generally, all of the tax treaties to 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, those individuals who qualify as a U.S. resident, 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" provision for individuals who claim tax treaty benefits as students, trainees, teachers and researchers. Therefore, if you are no longer an exempt individual, 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.
How to File Your Return
As a resident, you will file Form 1040, Form 1040A or Form 1040-EZ, whichever applies to you. 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, dependency exemptions, and any other deductions and credits to which a resident alien may be entitled. Mail the return to the Department of Treasury, Internal Revenue Service, Austin TX 73301.
Following are some examples that demonstrate the procedures you should use to determine your treaty benefits from IRS Publication 901. First, however, here are some definitions of treaty terms:
Sue from Belgium
Sue is a nonresident who came to the U.S. from Belgium in 2008 as an F-1 visa holder to study for her master's degree. Sue remained in the U.S. for all of 2011. In 2011 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 a wage as a teaching assistant of $7,500, and recognized $50 in dividend income 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 rather than Form 1040NR-EZ because she has dividend income, which is not effectively connected with Sue's U.S. trade or business. Tax on this income is computed on page 4 of Form 1040NR, and cannot be shown on Form 1040NR-EZ. Sue should receive a Form 1042-S from the university indicating the tax status of her scholarship payments. However, she should check IRS Publication 901 to determine if the university is treating it correctly.
She will look in Table 2 in Publication 901 and find the summary of the U.S./Belgium treaty for effectively connected income on page 39. Scholarship income is no longer listed as a category of income exempt by the treaty. However, under Code 19 (column 2) "Compensation during study or training" is shown in column 3. 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). 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).
With respect to her dividend income from a U.S. corporation, Sue should look at Table 1 in Publication 901, which begins on page 34. Table 1 indicates that dividends from a U.S. corporation received by a Belgium resident are taxed at 15% (column 6). Sue should report her dividends on page 4 of Form 1040NR and show that a 15% tax rate applies. Sue should also also report the treaty rate on dividends in Item L on page 5 of Form 1040NR. Bank interest is excluded income and is not reported on the return.
Julie from France
Julie is an F-1 student from France who arrived in the U.S. in 2007. In 2011 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 Table 2 in Publication 901 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 treaty purposes. Because Julie is a student, she should look under "studying and training" to see if an exclusion applies. Note 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 annually (p.a.) is excluded under Article 21(1). This should be shown as code 19 on her Form 1042-S.
Frederick from Germany
Frederick is a J-1 visa holder visiting the U.S. from Germany to teach and do research at the University of Minnesota. He plans to stay three years and is paid $15,000 per year. How is his income treated on his U.S. tax return?
Answer: Looking at Table 2 in Publication 901, Frederick would qualify for the first two years after his arrival for the exemption under code 18, Article 20(1) (an exemption for teaching generally applies to research too). Note the limit for the exemption is two years. If his stay exceeds two years, the exemption is not lost for the entire period, as was the case before signing of the 2006 Protocol between the US and Germany. However, Frederick is still required to be present only temporarily in the U.S. if his stay exceeds two year. Frederick should submit to the university Form 8233, Exemption From Withholding on Compensation for Independent Personal Services of a Nonresident Alien Individual.
Ed from Canada
Ed is a J-1 nonresident from Canada doing post-doctorate work at the University of Minnesota. In 2011 he received $12,000 in wages as a teaching assistant. How is his income treated on his U.S. tax return?
Answer: Note that Table 2 of Publication 901 says that up to $10,000 of dependent personal services compensation paid by a U.S. resident (or foreign resident) to a Canadian resident is excludable under Article XV of the U.S./Canada treaty. That might imply that Ed can exclude $10,000 of his $12,000 of wages from income. However, under the explanation on page 3 of Publication 901, if the taxpayer earns more than $10,000 the total amount is taxable. Therefore, Ed cannot exclude any income under the treaty.
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