Tax Treaties and Their Impact on Non-Resident Alien Taxation
Taxation for USA expats can be complex particularly because of USA tax laws and bilateral tax treaties.
The tax treaties can affect how non-resident aliens are taxed on income earned in the USA. Understanding the role of these agreements is important for the non-resident aliens (NRAs) to reduce their tax liabilities and avoid double taxation.
What are Tax Treaties?
A tax treaty is a bilateral agreement between the two countries to solve the issue of double taxation. Double Taxation occurs when an individual or business is taxed by two different countries on the same income.
The USA has tax treaties with more than sixty countries to reduce or eliminate tax barriers for individuals and companies that earn income across borders. For Non-Resident Aliens, tax treaties provide tax provisions, such as income tax rates, exemptions and deductions. The agreements result in reduced tax rates or even exemptions on certain income such as interest, dividends or capital gains.
Also read:- Expat Taxes for US Citizens and resident aliens abroad
How the US Tax Treaties Work?
When NRA earns income in USA, they are subject to tax under the USA domestic tax laws. However with USA tax treaties, NRAs can avail a more favorable tax situation.
The main benefits of US tax treaties include-
1. Reduced withholding rates: US tax laws impose 30% withholding tax on payments to NRAs. The tax treaties lower the tax rates for certain incomes including interests or dividends. In USA-Canada tax treaty, the withhold rate on dividend is reduced to 15%.
2.Avoid Double Taxation: Without the tax treaties, NRAs could be taxed on the same income by both the US and their home country. The tax treaty ensures that the individuals are not taxed twice on the same income by providing tax credits or exemptions.
3. Exemptions for teachers and students: Many tax treaties contain a special provision allowing students, teachers and researchers to be exempt from US taxes on income earned from teaching, studying or conducting research. Under US-India tax treaty, the Indian students can claim exemptions on income earned from grants or scholarships.
4. Business Profits: Tax treaties have provisions related to business profits earned by NRAs. If a non-resident alien operates a business in the USA but does not have a permanent establishment, the treaty will exempt them from USA taxes on the business income.
In order to claim tax treaty benefit, non-resident alien must file appropriate form with the IRS. The most commonly used form is Form W-8BEN, allowing the NRAs to claim reduced tax rates or exemptions under the applicable treaty.
USA tax treaties play a crucial role in shaping the tax obligations of non-resident aliens. It helps them reduce the impact of double taxation and ensure NRAs are fairly taxed. Navigating the USA tax treaties can be complicated, it is advisable for the NRAs to take a professional guidance and support from an expert tax service provider to avoid costly mistakes and optimize their tax situation.
