How Tax Treaties Can Affect Your Taxes

Many countries, including the U.S., tax citizens’ worldwide income — even if they aren’t living or working in their country of origin. In addition, most countries in the world will tax income generated by a person working and living within the country. That means a U.S. citizen living and working in Peru will be taxed by the U.S. government and the Peruvian government on his or her Peruvian income. This might sound troubling at first, but the reality is that there are a number of treaties out there to protect citizens from double taxation.

For example, there are tax treaties between the U.S. and numerous other countries. Under these tax treaties, residents of foreign countries living in the United States may be taxed at a lesser rate or, in some cases, may be excused from paying U.S. income tax altogether on certain sources of income. In the UK, a similar system is at work. The UK has specific double tax agreements with various foreign countries. These agreements provide tax relief for UK citizens abroad who are taxed on their sources of income by both the UK and the country that the income is sourced from. This relief will typically allow a UK citizen to get all or part of his or her taxes back per the double-taxation agreement.

Overall, tax treaties can save expats a good deal of money, helping them avoid the costs of double taxation. However, the extent of relief that a tax treaty provides is contingent on several factors. How a tax treaty will affect your taxes largely depends on the countries in question and your overall income level, as well as a number of other things. When considering how a tax treaty will affect your taxes, here are a few questions you want to keep in mind.

  • What is your country of origin? Ultimately, different countries have different ways of taxing citizens’ income generated from abroad. The U.S. is stringent in this respect in that all citizens have tax obligations generated on all income worldwide. Australia operates on a similar model. However, many other countries, including many European countries, aren’t as strict.
  • How much money do you earn? In the majority of countries, your tax liabilities in relation to foreign-sourced income will increase as you make more money. In the United States, for example, U.S. citizens don’t have to pay taxes on their first $100,800 of foreign income as per foreign earned income exclusion regulations. After that, however, U.S. citizens may be subject to double tax on some foreign income.
  • Would foreign income be taxed at a lower rate in your home country? If you are living in a country with a higher tax rate than your country of origin, then you probably won’t be able to get all of your foreign tax back. In the UK, for example, UK citizens may not get the full amount of foreign tax paid back to them if the income would have been taxed at a lower rate in the UK.

Ultimately, it is important to note that navigating different countries’ tax laws and systems can be confusing. When you throw a tax treaty into the mix, things can become even more convoluted. If you’re having trouble working out how a tax treaty will affect your individual tax situation, it is probably best to contact a professional for guidance and assistance.

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