The process of globalization, the expansion of international trade, and the high mobility of people, capital, and services have raised many issues in taxation as well. If until now a person’s source of income originated from his place of residence, and all transactions have been done in the same political territory. In this new era, one must deal with a changing reality in which trade is international and the person may have sources of income even outside his country of residence.
In this new reality, a person could find himself paying for the same tax (income tax) in two different countries. Such a situation could discourage international trade, and ultimately harm the economic development of all the countries involved.
In order to cope with this changing reality and prevent double tax liability that can happen in the case of international trade, tax treaties have been drafted between the countries. This treaty establishes agreements between the states regarding which country gets priority in collecting the tax on the different types of income. Israel is a signatory to tax treaties with many countries, but the most important tax treaty is the one signed in 1995 with the United States.
In the article here, we will discuss the importance of the tax treaty between Israel and the United States, list the revenues it includes, and more importantly, we will list the revenues that are not included in it. This information is critical for dual U.S. citizens, and for anyone with an income stream originating from the United States.
The Significance of the Israel-United States Tax Treaty
As mentioned above, the purpose of the tax treaties is to prevent a situation where one must pay tax twice. However, when it comes to the United States, this treaty is of even greater importance. The reason for this lies in the American taxation system. The United States is not satisfied with imposing tax liability based solely on one’s country of residency (as is customary in most countries of the world). Thus, the U.S. tax liability applies to the foreign income of American citizens even if they have never visited the United States.
In light of this taxation system, an Israeli citizen who has U.S. citizenship will also be obligated to report and pay tax on his income generated in the State of Israel. Not only that, but the tax liability also applies to foreign citizens whose income comes from the United States. Therefore, even an Israeli citizen who is not a resident of the United States and is not a citizen of the United States can be taxed by the United States (in addition to the Israeli tax) if he invests in real estate or securities in the United States.
If so, in the absence of a double tax treaty, the U.S. tax system could create a double tax liability.
The Principles of the Israel-United States Tax Treaty
Based on the crucial importance of this matter between the United States and Israel, the Tax Treaty between the two countries was signed in 1995. The treaty addresses the taxation systems of the countries, the division of tax between them, and it determines which one of the countries will collect the tax first. In addition, the treaty includes a section dealing with double taxation. And so, almost all types of income will not be collected from the taxpayer twice, but it will be collected in the country where the tax rate is higher.
For example, if the tax on any income is 12%, and in Israel 10%, the taxpayer will pay tax at a rate of 12%. If, on the other hand, the tax in the United States is lower and stands at 10%, while the tax in Israel stands at 20%, 10% will be paid in the United States and the rest (an additional 10%) in Israel.
Another important issue addressed by the treaty is the income of non-U.S. citizens but who have income that originates in the United States. And so, the treaty determines whether the taxpayer will be taxable or exempt based on the type of the income (for example, a two-year tax exemption for teachers in a recognized educational institution, exemption for students and trainees, etc.).
Israel-United States Tax Treaty – Income Not Included in the Covenant
Self Employment Tax
The self-employment tax is a tax levied on the self-employed in addition to the tax on their income. This tax is the American equivalent to the Israeli Social Security fees. The fact that there may be a scenario in which an Israeli citizen who is paying Social Security in Israel is liable for self-employment tax in the United States, raises the question of double taxation once again.
However, the double-tax treaty does not apply to social security, for this purpose, there are no specific treaties that were signed with the United States. Therefore, that Israeli citizens will have to pay Social Security in Israel as well as self-employment tax in the United States. However, social benefits given out by the state will not be tax-free in both countries.
Pension
For American pensions, the convention would mostly prevent a scenario of double taxation and would even include certain exemptions. The situation is different when it is an Israeli pension. Regarding Israeli pensions, there is a lack of clarity and interpretive dispute regarding the provisions that apply to them. Some believe that the profits of the pension during the accrual years are taxable, others believe that these profits are not taxable throughout the years and are only taxable when they are withdrawing (although in Israel they may be tax-free, at least partially).
Since the Covenant may reduce the payment of tax on pensions, and on the other hand it may also impose a heavy tax liability – we strongly recommend that dual citizens who have a pension receive professional advice on the matter, advice that will ensure a minimal tax liability.
Closing words
The tax treaty between Israel and the United States includes many complicated provisions and was not updated to better match the changes in international trade that took place in recent years. The professional and correct tax management that includes classification of income under preferred categories, will ensure a minimum tax burden. On the other hand, incorrect classification of income may impose a heavy tax liability. In light of the complexity and importance of the issue, we strongly recommend receiving professional tax counseling.
Want to know what are the preferred categories or how tax liability can be reduced – Mas America’s experienced team is well versed in all the professional secrets and will be happy to be at your disposal.
