WHAT IS 'Bilateral Tax Agreement'

A bilateral tax agreement, also called a tax treaty, is an arrangement between two jurisdictions that mitigates the problem of double taxation that can occur when tax laws consider an individual or company to be a resident of more than one jurisdiction. A bilateral tax agreement can improve the relations between two countries, encourage foreign investment and trade, and reduce tax evasion.

BREAKING DOWN 'Bilateral Tax Agreement'

Bilateral tax agreements are often based on conventions and guidelines established by the Organization for Economic Cooperation and Development (OECD), an intergovernmental agency representing 35 countries. The agreements can deal with many issues such as taxation of different categories of income (business profits, royalties, capital gains, employment income, etc.), methods for eliminating double taxation (exemption method, credit method, etc.), and provisions such as mutual exchange of information and assistance in tax collection. As such they are complex and typically require expert navigation from tax professionals, even in the case of basic income tax obligations. Most income tax treaties include a “saving clause” that prevents citizens or residents of one country from using the tax treaty to avoid paying income tax in any country.

Bilateral Tax Agreements and Residency

A primary consideration is the establishment of residency for tax purposes. For individuals, residency is generally defined as the place of primary domicile. While it is possible to be a resident of more than one country, for tax purposes only one country can be considered the domicile. Many countries base domicile on the number of days spent in a country, requiring careful record keeping of physical stays. For example, most European nations consider anyone who spends more than 183 days per year in country to be domiciled and thus liable for income tax.

The United States Is Different

Unique among developed nations, the United States requires all citizens and green card holders to pay U.S. federal income tax, regardless of domicile. To prevent onerous double taxation, the U.S. provides the Foreign Earned Income Exclusion (FEIE), which in 2018 allowed Americans living abroad to deduct the first $104,100 in earnings, but not passive income, from their tax return. The earnings can come from either a U.S.- or foreign-based source. However, if the income is from a U.S. company, the IRS expects the taxpayer and the employer to pay payroll taxes, currently around 15 percent of $100,000 in earnings. Income from a foreign source is usually exempt from payroll taxes. Foreign taxes paid on earned income beyond the exclusion amount can often be deducted as a Foreign Tax Credit.

RELATED TERMS
  1. Tax Treaty

    A tax treaty is a bilateral agreement made by two countries to ...
  2. Double Taxation

    A taxation principle referring to income taxes that are paid ...
  3. Worldwide Income

    Worldwide income is an aggregation of a taxpayer's domestic and ...
  4. Tax Break

    A tax break is a savings on a taxpayer's liability. It is also ...
  5. Foreign Earned Income Exclusion

    The foreign earned income exclusion excludes income earned and ...
  6. IRS Publication 54

    A document published by the Internal Revenue Service that outlines ...
Related Articles
  1. Taxes

    How to Reduce U.S. Taxes on Foreign Income

    IRS rules allow for a few ways to reduce taxes on foreign-earned income.
  2. Taxes

    Which Countries Have the Highest Taxes on High Incomes?

    For high earners in these countries, the tax rate percentage on income exceeding a certain threshold can reach into the high 50s and low 60s.
  3. Taxes

    Taxes: Who Pays And How Much?

    When it comes to taxes, the debate is endless on who pays what, especially in Congress. With no new initiatives in sight, let's take a look at who is paying now.
  4. Financial Advisor

    3 Federal Income Tax Facts You Didn't Know

    Learn about three federal income tax facts that most Americans may not know from one of the most trusted financial resources on the Web.
  5. Insights

    How Fortune 500 Companies Avoid Paying Income Tax

    President Donald Trump is not alone in not paying taxes.
  6. Taxes

    How Tax Cuts Stimulate the Economy

    Learn the logic behind the belief that reducing government income benefits everyone.
  7. Insights

    A Concise History Of Changes In U.S. Tax Law

    We look at how U.S. taxes have changed since their inception.
  8. Taxes

    The History of Taxes in the U.S.

    America's first citizens enjoyed few to no taxes. Then taxes were added, increased and occasionally repealed to give us our current tax regime.
  9. Taxes

    5 State Tax Issues For When You Leave the Military

    When you're budgeting for post-military life, certain state tax issues need to be considered.
  10. Taxes

    The Top 10 European Tax Havens

    While the popular stereotype of a tax haven is a Caribbean island, these countries in Europe serve as attractive places for foreign individuals and companies to store funds.
RELATED FAQS
  1. What is the difference between a state income tax and a federal income tax?

    Learn the difference between state income tax and federal income tax based on tax rates, deductions, tax credits and taxable ... Read Answer >>
Trading Center