Tax Treaties and the Savings Clause
Overview of Tax Treaties:
The United States has income tax treaties with a number of foreign countries. Under these treaties, residents (not necessarily citizens) of foreign countries are exempt from US income tax or taxed at a reduced rate on certain types of income received from a US source. The tax treaties vary; some allow for tax exemption and reduction on many differnt types of income while others do not. If a tax treaty does not address a specific type of income, then no tax exemption or reduction can be applied to that income and persons receiving that income will have to pay US federal income tax.
Do States Honor Tax Treaties?:
Some states honor the provisions of U.S. tax treaties but some states do not. The state of Tennessee does not require individual income tax withholding so international persons living in Tennessee and receiving income from a US source do not pay state income tax. If you do not live in Tennessee, or are required to file a tax return in another state, please check the requirements of that state with the appropriate state revenue office.
Students, Apprentices, Trainees, Teachers, Professors, and Researchers Who Became Resident Aliens for Tax Purposes:
Generally, you must be a nonresident alien student, apprentice, trainee, teacher, professor, or researcher in order to claim a tax treaty exemption. Once you become a resident alien, you generally can no longer claim a tax treaty exemption for this income. However, if you entered the United States as a nonresident alien for tax purposes, but are now a resident alien for tax purposes, the treaty exemption may continue to apply if the tax treaty has a exception to its savings clause (see below) that allows you to continue to claim treaty benefits.
Saving Clause & Exception to Saving Clause:
Most tax treaties have a saving clause and it is important to understand what the savings clause means. A saving clause preserves or “saves” the right of each country to tax its own residents as if no tax treaty existed. Therefore, if you become a resident alien for tax purposes in the USA, you generally lose any tax treaty benefits.
However, many tax treaties also have an exception to the saving clause. The exception to the saving clause usually allows you to to continue to claim certain treaty benefits even when you become a resident alien for tax purposes. Please review your tax treaty carefully to find out if it has a saving clause and/or and exception to the saving clause.
Time Limit for Claiming Tax Treaty Benefits:
Many treaties limit the number of years you can claim a treaty exemption. For international students, apprentices, and trainees, the limit is usually 4–5 years from the date of entry into the USA. For teachers, professors, and researchers, the limit is usually 2–3 years from the date of entry into the USA. Once you reach this limit, you can no longer claim the tax treaty exemption. It is important to not that the tax treaty benefit clock begins as of the date you enter the USA. Therefore, if you do not claim tax treaty benefits during the allowed time, you cannot claim them later. For example, a J-1 researcher who enters the USA on January 1, 2010 who can claim tax treaty benefits for two years, must claim those benefits in 2010 and 2011. If the J-1 researcher does not earn any income in the USA for the first two years, the opportunity to claim tax treaty benefits is lost unless an exception to the saving clause exists.
Another example: F-1 student enters the USA on August 1, 2006. Student earns no income for first three years but receives a paid internship in last semester of senior year (i.e. 2010), has a year of Optional Practical Training and then continues on to graduate studies and works as a graduate teaching assistant from August 2011 - May 2013. Since the student arrived in the USA in August 2006, tax treaty benefits could be claimed for no more than 5 years. The student can claim the tax treaty benefits in 2010, 2011 only; for the additional pay as a graduate teaching assistance, the student must pay US income tax unless an exception to the saving clause exists.