written by: Deb Kramer

Dividends and interest earned from a foreign corporation, wages earned outside of the U.S. and retirement earnings/gains carry with them another tax code animal, referred to as, International Taxation.  Discerning the rules that are applied to each situation and the “income” that will be taxed is dependent on the countries and treaties in place.  Our goal today is to become aware of some of the issues surrounding International Taxation. We shall focus on the perspective of the U.S. taxpaying resident spending time abroad.  If you have any questions please call to make an appointment concerning your unique situation. 

Tax treaties exist between countries to prevent double taxation (or taxes paid twice on the same income, profit, capital gain, inheritance or other item).  Most developed countries have a large number of tax treaties in place to establish guidelines and rules covering all types of earnings handled or earned within their country.

Generally, U.S. taxpayers are taxed on their worldwide income, but the country of origin, (a.k.a. place where the income was generated) may also tax the income.  The differences in tax rates between the two countries are resolved by the tax treaties which state who gets the tax and how much is collected. 

The taxes that you pay on your foreign income can lead to either a deduction or a credit against tax liability. The foreign tax credit is limited by the ratio of foreign to US income. 

You may not get credit on your current year tax return for the full amount of foreign tax paid if the foreign tax rate is higher than your US tax rate.  Any disallowed amount will not be lost and may be carried forward for 10 years. 

If you have worked overseas for a period of time, some of the income may be eligible for the “foreign income exclusion”.  Simply put, this refers to the amount of time present in the foreign country and how much is able to be taxed at U.S. rates.  There are many rules to this exclusion so in an effort to stay on track call the office with questions pertaining to your unique situation.

Foreign source income is everything earned outside of the taxpayer’s country of permanent residence.  U.S. sourced income is defined as income earned from the United States or the District of Columbia.  It does not include income from any U.S. possessions/territories, such as Puerto Rico and the Virgin Islands.   

Generally, income is taxed by the country the income was earned in, “source country”.  Different sourcing rules apply to different types of income earned.   

• Interest income is generally taxed by the country of the borrower,
• Dividend income  to the country in which the paying corporation is incorporated,
• Personal service income, (income that comes from using your personal skills) to the country where the services are actually performed,
• Rental income belongs to the country where the property is located and royalties to the country where they are used or the country whose laws protect the owner of the property against unauthorized use. 
• Sales of purchased inventory is sourced based on where title to the goods passes.  The general rule on personal property is that sale by a US resident will be sourced 100% US regardless of where the title passes.  Gains on sales of real property are sourced according to the physical location.  However, the U.S. real property interest held directly or indirectly by a nonresident alien is taxed in the U.S.
• Retirement plans and deferred compensation are sourced where the services were originally performed, which may be different than where you currently live, especially if you have chosen to retire outside the US. 
• Commissions are sourced where the service that earned the income was rendered, not where the goods were manufactured or delivered. 

There is also a requirement to allocate income earned in various countries between those countries.  For example, hockey players and pro golfers may earn income and have expenses in multiple jurisdictions.  In these cases, payment is apportioned between the countries where the services were performed.  That is determined “by facts and circumstances” and can be quite complicated.  Determining the allocation has been the point of numerous court cases.

There are so many exceptions and special rules when dealing with international taxation and the differing treaties with various countries that you really MUST seek COMPETENT PROFESSIONAL ADVICE and provide all relative information so all rules applied can be accurately determined. Companies doing business abroad have even more complicated rules to abide by and are outside the scope of this article. To avoid surprises concerning where and how your income is sourced and thus the amount and jurisdiction for the tax liability, please contact us directly.  We are available to discuss your plans for the future and protect your potential earnings.