How to Qualify for a Tax Treaty-Based Return Reporting Disclosures

How to Make a Tax Treaty-Based Return Reporting Disclosure

How to Make a Tax Treaty-Based Return Reporting Disclosure                 

The United States has entered into several different international tax treaties with foreign countries with the overall goal of avoiding double taxation on various types of income. While many of the tax treaties are very similar, each tax treaty is different — and therefore taxpayers have to be careful to make sure that they carefully assess the specific tax treaty they want to rely on in order to make a proper tax treaty-based return reporting disclosure. In general, taxpayers who are in a treaty country may qualify to take a treaty position on various matters. To do so, the US Taxpayer can include a Form 8833 (unless otherwise excluded from the reporting requirement) to make a treaty-based election. There are several pros and cons regarding a treaty-based return disclosure and Taxpayers should speak with a Board-Certified Tax Law Specialist first and carefully consider the pros and cons before making the election. Let’s go through the basics of how to qualify for a tax treaty-based return reporting disclosure.

Purpose of a Tax Treaty-Based Return Reporting Disclosure

As provided by the IRS:

• • • Form 8833 must be used by taxpayers to make the treaty-based return position disclosure required by section 6114 and the regulations thereunder (Regulations section 301.6114-1). The form must also be used by dual-resident taxpayers (defined later) to make the treaty-based return position disclosure required by Regulations section 301.7701(b)-7. A separate form is required annually for each treaty-based return position taken by the taxpayer, although a taxpayer may treat payments or income items of the same type received from the same payor as a single item for reporting purposes.

Who Must File a Tax Treaty-Based Return Reporting Disclosure

As provided by the IRS:

• • • Generally, a taxpayer who takes a treaty-based return position must disclose that position, unless reporting is specifically waived. See Exceptions from reporting below. A taxpayer takes a treaty-based return position by maintaining that a treaty of the United States overrules or modifies a provision of the Internal Revenue Code and thereby causes (or potentially causes) a reduction of tax on the taxpayer’s tax return.

    • For these purposes, a treaty includes, but is not limited to, an income tax treaty; estate and gift tax treaty; or friendship, commerce, and navigation treaty.

Examples of when a Tax Treaty-Based Return Reporting Disclosure is Required

As provided by the IRS:

• • • That a nondiscrimination provision of the treaty prevents the application of an otherwise applicable Code provision, other than with respect to making an election under section 897(i);

    • That a treaty reduces or modifies the taxation of gain or loss from the disposition of a U.S. real property interest;

    • That income effectively connected with a U.S. trade or business of a taxpayer is not attributable to a permanent establishment or a fixed base in the United States; that a treaty modifies the amount of business profits of a taxpayer attributable to a permanent establishment or a fixed base in the United States;

    • That a treaty alters the source of any item of income or deduction (unless the taxpayer is an individual);

    • That a treaty grants a credit for a foreign tax which is not allowed by the Code;

    • That the residency of an individual is determined under a treaty and apart from the Code. See Dual-resident taxpayer below.

Exceptions to Reporting

As provided by the IRS:

• • • That a treaty reduces or modifies the taxation of income derived by an individual from dependent personal services, pensions, annuities, social security, and other public pensions, as well as income derived by artists, athletes, students, trainees, or teachers;

    • That a Social Security Totalization Agreement or Diplomatic or Consular Agreement reduces or modifies the income of a taxpayer;

    • That a treaty exempts a taxpayer from the excise tax imposed by section 4371, but only if certain conditions are met (for example, the taxpayer has entered into an insurance excise tax closing agreement with the IRS);

    • That a treaty exempts from tax or reduces the rate of tax on FDAP income, if the beneficial owner is an individual or governmental entity;

    • If a partnership, trust, or estate has disclosed a treaty position that the partner or beneficiary would otherwise be required to disclose;

Dual Resident & Tax Treaty-Based Return Reporting Disclosures

As provided by the IRS:

• • • An alien individual is a dual-resident taxpayer if that individual is considered to be a resident of both the United States and another country under each country’s tax laws.

    • If the income tax treaty between the United States and the other country contains a provision for resolution of conflicting claims of residence by the United States and its treaty partner, and the individual determines that under those provisions he or she is a resident of the foreign country for treaty purposes, the individual may claim treaty benefits as a resident of that foreign country, provided that he or she complies with the instructions below.

    • If you are an individual who is a dual-resident taxpayer and you choose to claim treaty benefits as a resident of the foreign country, you are treated as a nonresident alien in figuring your U.S. income tax liability for the part of the tax year you are considered a dual-resident taxpayer.

    • If you are eligible to be treated as a resident of the foreign country pursuant to the applicable income tax treaty and you choose to claim benefits as a resident of such foreign country, you must file Form 1040-NR, U.S. Nonresident Alien Income Tax Return, with Form 8833 attached.

    • A dual-resident taxpayer may also be eligible for U.S. competent authority assistance. See Rev. Proc. 2015-40, 2015-35 I.R.B. 236, or its successor. If you choose to be treated as a resident of a foreign country under an income tax treaty, you are still treated as a U.S. resident for purposes other than figuring your U.S. income tax liability (see Regulations section 301.7701(b)-7(a)(3)).

Treaty Elections are Complicated

In general, taxpayers should carefully consider the pros and cons of making a treaty-based election before doing so. That is because the election can increase the chance of an audit or examination—depending on the category and type of election. Moreover, the election will carry forward for many years to come, and if a taxpayer later wants to unwind the election, it could become a very complicated and cost-intensive exercise.

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