January 24, 2022

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What is the United States Income Tax Treaty and how does it relate to double taxation?

4 min read

In simple terms,  the Treaty is some kind of contract between the USA and its citizens. Not just any contract, but a tax agreement. Meaning each U.S. citizen, who lives around the world will essentially be asked to pay tax on his taxable income, even if he currently not residing in the U.S. and even if he is currently abiding in another country to which he has a citizenship status.  Yes, even if he is already paying tax to the state in which he resides.

An overview:  The Income Tax Treaty

Let us back off for a moment. USA Israel Tax Treaty is not exclusive to the U.S. Over seventy-four countries do have an Income Tax Treaty with the U.S., yes, Israel included. The Israelian Tax Treaty dates to 1995 and some will say it has not been updated then. This might sound odd given a tremendous amount of global changes in the last 25 years or so.

The Israel – U.S. Income Tax Treaty might be highly relevant to people who hold dual citizenship in both countries while also paying taxes to both within the same income streams. Given the relevancy of the Tax Treaty to tax deductions for dual citizens, it might be valuable to understand what it entails and what are some of its aspects.

What is the purpose of the Income Tax Treaty?

Some might say it is highly unusual for the U.S. to tax worldwide income. Yet, here it is, the Tax Treaty. To put that in perspective,  if you are an American residing in Israel, it might be possible that your taxable income is given to taxes by both the U.S. and Israel’s tax authorities. Yet, if you were French and earned a living in Israel, the French probably will not go for your taxes regarding that income stream. Hence the U.S. Income Tax Treaty. It might be relevant for people who are well aware of their American citizenship and tax duties, and it might be relevant for people who are not aware of what their American citizenship entails. They might have yet to realize what the treaty is and how it might be relevant in their context. They might not even have stepped a foot on U.S. land. They might have had their citizenship awarded to them on the merit of being born on American land. In which case, any information on the U.S. tax laws, including the Treaty, might be helpful and insightful.

Long story short, the Tax Treaty serves to protect against double taxation. Meaning, the payment of a redundant amount of tax to both countries’ tax authorities. People will not be charged the full amount on both fronts. While either Israel or the U.S. will get the first bite out of a specific income stream. Meaning, the tax incurred by the U.S. tax authorities will not be incurred by the Israelian tax authorities, and vice versa, following the tax laws.

Upon investigation: The merits of knowing your rights (in regards to tax laws)

Nevertheless, the Income Tax Treaty might leave some people susceptible to higher rates of tax brackets in some categories of income.  That is because the “second party” will get what the “first party” has left, as a tax payment. The first party is the country that gets the “first bite” out of the tax income, while the second party in the country gets what is left. So, if an American citizen resides in Israel and is capable of paying about 10% tax on a stream of income, he may need to up that amount after Israel gets its first bite. Meaning, the first 10% will go to Israel, and then, concerning the U.S. taxation laws, the citizen might be asked to pay an additional sum according to the agreed-upon tax. So, if the U.S. tends to tax about 40% on the same issue Israel tends to tax 10% of, then Israel gets first bite (in that scenario), while there are still 30% left for the U.S. tax authorities to deduce.

In that case, it seems a dual citizen might be paying the highest rate of tax available in each income category, since it seems that even if he is able to pay less tax due to lower taxation in one country, he will pay “the rest”, of the highest rate available to the “second country”. In which case he will pay less tax to Israel’s tax authorities, and “the rest of it” (approaching the highest tax rating) to the U.S. tax authorities.

Actionable item: Seek guidance

There are a lot more aspects to the Income Tax Treaty, yet we can easily see that even though it does serve to protect against double taxation, it does incur a higher rate of taxes. Before proceeding to make due payments, it might be of benefit to involve a C.P.A that might present new options for some rearrangements. Tax rearrangements, which are appropriate to actualize a wider berth of one’s financial rights, using the law itself to pay fewer taxes in a state of dual citizenship. Even in the context of the Income Tax Treaty.

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