What is a Tax Treaty?

Mary McMahon
Mary McMahon

Man climbing a rope
Man climbing a rope

A tax treaty is a legal agreement between two nations to address concerns about double taxation of individuals and companies doing business, living, and earning income in two or more nations. Under the terms of the treaty, certain people may qualify for reduced tax rates on some kinds of income if they provide the right documentation. People who want to know if they are eligible for special treatment under a tax treaty can consult an accountant, tax attorney, or government tax agency to find out more.

In a simple example of how a tax treaty can work, a US citizen working in Britain would normally be obliged to pay taxes to the British government, as well as the Internal Revenue Service in the United States on any income earned in a given tax year. This would result in double taxation, where the person is paying taxes twice on the same income. A tax treaty may allow the person to receive reduced tax rates in either country, or to do things like claiming credit for taxes paid in one nation when filing taxes in another. The goal is to avoid a situation where the bulk of someone's income is eaten up in taxes.

People may be subject to a tax treaty if they are living and working in a foreign country or receive sources of foreign income, like companies operating overseas. A journalist, for instance, might be based in Britain, but receiving payments from publications in nations like the United States. People need to carefully document all sources of their income and any taxes paid to make sure they file their taxes properly, and to prepare for requesting allowances under a tax treaty.

Tax treaties may also have an impact on withholding. When people start a job, they fill out paperwork the employer will use to determine how much to withhold from each paycheck. If there are special tax treaty considerations, it may be necessary to file a different form or supplement to make sure the employer withholds the appropriate amount. People who are not sure about how to handle income from foreign sources or while working overseas should discuss the situation with an accountant before receiving payments, to avoid any mistakes.

Negotiating a tax treaty usually requires concessions on both sides. Agreements on taxes, tariffs, and other matters change frequently, and people should make sure they operate using the most up-to-date information. Making decisions on the basis of outdated information or filling out prior year tax reforms can have serious consequences; at best, tax agencies will require a person to refile and a fine for late taxes may be imposed, but at worst, there may be suspicions of fraud, requiring an audit and possible penal measures.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

You might also Like

Readers Also Love

Discuss this Article

Post your comments
Forgot password?