When Tax Treaties Don’t Help U.S. Expats
For many taxpayers, bilateral treaties can be an important tool for eliminating double taxation – i.e., tax in both the country of income source and the country of taxpayer residence or citizenship. For instance, dividend or interest payments made by a payor that is resident in one country may be exempted from income tax by such country, assuming that the interest income is taxed by the other country in which the payee resides.
In the case of most U.S. tax treaties, however, tax benefits are significantly limited in the case of U.S. citizens living abroad. Instead, double taxation is reduced or eliminated by domestic provisions, such as the foreign earned income exclusion and the foreign tax credit.
The Saving Clause
The mechanism by which the reach of U.S. tax treaties is limited for U.S. citizens (and resident aliens) is referred to as the “Saving Clause”. This is a provision built into U.S. tax treaties that guarantees the right of the United States to impose taxation on its citizens as though the treaty didn’t exist. The clause is designed primarily to preserve (“save”) the ability of the United States to tax its residents and citizens on their worldwide income.
It should be noted that U.S. tax treaties often make exceptions to the clause for students, teachers, researchers and trainees, and in the case of some pension provisions.
Saving Clause in Action
The Saving Clause has been applied by the IRS and confirmed by U.S. courts in a number of instances.
In a 1993 field service advice (1993 FSA LEXIS 26349), the IRS advised that a U.S. citizen living in the United Kingdom was taxable on U.S. social security benefit payments he received, due to the Saving Clause, even though the payments would otherwise be taxable only in the United Kingdom under the U.S.-U.K. treaty. (It should be noted that the treaty has since been amended to allow the benefit of non-taxation in the U.S. in this scenario.)
In a 1996 private letter ruling (PLR 9628024), the IRS ruled that a settlement payment received by a U.S. resident alien in satisfaction of amounts owed under an employment agreement was taxable, even if the payment would otherwise be exempt under the relevant treaty, due to the Saving Clause “preserving the right of the United States to tax its residents as if the Treaty had not come into effect.”
In a very recent court decision (T.C. Summary Opinion 2016-22 (May 2016)), the U.S. Tax Court upheld an IRS notice of deficiency against a U.S. citizen living in Israel, finding that the U.S.-Israel tax treaty’s Saving Clause prevented the individual from using the treaty to exclude capital gain from his taxable income.
At Expat Tax Professionals, our experts have extensive experience in utilizing all of the tax benefits available to U.S. expats, including treaty benefits when available. We have helped many expats significantly reduce or eliminate their U.S. tax obligations using one or more of these benefits. We are ready to help you with your U.S. tax filings. Please Contact us today!
By Ephraim Moss, Esq. & Joshua Ashman, CPA