Understanding the US Luxemboug Tax Treaty is crucial for U.S. expats living in Luxembourg and to Luxembourgish residents who are non-US citizens with U.S. sourced income. This guide breaks down the treaty's provisions, offering clarity on how it affects personal taxation and helps avoid double taxation.
Executive Summary
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What is the U.S. Luxembourg Tax Treaty?
The U.S. Luxembourg tax treaty, signed in 1996, serves as an agreement between the two countries for determining the taxation of income where both nations may have the legal right to tax according to their respective laws. The treaty covers, among many topics, avoidance of double taxation, residency tie-breakers and taxation of various forms of income, including business profits, dividends, interest, pensions, and capital gains. This article will focus on some of the key aspects of the treaty that hold particular significance.
Relief of Double Taxation
The Luxembourg U.S. tax treaty provides mechanisms for relief from double taxation, ensuring that income earned in one country by residents or citizens of the other is not taxed twice. To avoid double taxation, the treaty allows U.S. expats to claim a foreign tax credit for the income tax they pay on Luxembourgish sourced income to Luxembourg against their U.S. tax liability. Conversely, Luxembourg offers a credit for U.S. taxes paid on U.S. sourced income against its own tax liabilities.
Example
Nicolas Muller, a U.S. citizen living in Luxembourg City, Luxembourg, earns an annual salary of $80,000 and pays $25,000 in taxes to Luxembourg for the year. Nicolas's U.S. tax liability for this income amounts to $22,000. Thanks to the relief of double taxation provision of the tax treaty, he is entitled to claim a foreign tax credit on his US taxes. Nicolas applies the $25,000 he paid in Luxembourgish taxes against his U.S. tax obligation, effectively reducing his U.S. tax liability to zero and even generating a $3,000 credit surplus, which may be carried over to subsequent tax years.
What is the Savings Clause?
The Luxembourg U.S. tax treaty contains a "savings clause" which preserves the right of the U.S. to impose taxes on its citizens according to its own laws, even if this contradicts the provisions of the treaty. As a result of this clause, the majority of the benefits and reductions offered by the treaty do not apply to U.S. citizens living in Luxembourg.
Example
Anne Schneider, a U.S. expat, resides in Luxembourg City, Luxembourg, and works for an American bio-tech company. She performs all her work duties in Luxembourg and has no physical presence in the U.S. Although the Luxembourg U.S. tax treaty exempts such income from U.S. taxation on the basis that there is no permanent establishment in the U.S., the savings clause overrides this, requiring Anne to declare and possibly pay U.S. taxes on her income. Nevertheless, Anne can take advantage of the foreign earned income exclusion or foreign tax credits for the taxes paid in Luxembourg to avoid being taxed twice on the same income.
​Expert Tip: It's crucial for U.S. citizens to familiarize themselves with the savings clause exclusions in the tax treaty to accurately determine which tax benefits they can utilize. |
What are the Residency Tie-Breaker Rules?
The United States and Luxembourg have their own criteria for determining who is a resident for tax purposes. It's possible for someone to meet the residency requirements of both countries simultaneously. To prevent the problems that dual tax residency could cause, the U.S. Luxembourg tax treaty provides a series of tie-breaker rules. These rules help to decide which country has the primary right to tax the individual's income.
Permanent Home Test: The first consideration is whether the individual has a permanent home available to them in one of the countries. If a permanent home is available in only one country, that country is generally considered the individual's country of residence for tax purposes.
Centre of vital interests Test: If the individual has a permanent home in both countries or in neither country, the treaty looks at where the individuals center of vital interests lies, in other words, where they have a closer personal and economic interests.
Habitual Abode Test: If the individual has a center of vital interests in both countries or in neither country, the treaty looks at where the individual has a habitual abode; in other words, where they live regularly. This could be where they spend more time or where they have a regular presence.
Nationality Test: If the individual has a habitual abode in both countries or in neither, the next factor considered is nationality. If the person is a citizen of only one of the countries, that country is typically considered their country of residence for tax purposes.
Mutual Agreement Procedure: In the rare case that the individual is a citizen of both countries or of neither, and the above tests do not resolve the issue of residency, the competent authorities of the United States and Luxembourg will determine the individual's residency through a mutual agreement, taking into account the person's facts and circumstances.
Taxation of US-Sourced Passive Income
Passive income from U.S. sources, which is not tied to a U.S. trade or business, is generally taxed at a flat rate of 30% if earned by a non-resident alien. However, the US Luxembourg tax treaty lowers this rate and in some cases totally exempts it from US taxation for certain types of income. We've summarized some of the tax treaty rates in the table below. It's important to note that that these rates generally do not apply to U.S. citizens due to the savings clause mentioned earlier.
Tax Rate | Treat Article Citation | |
​Interest | 5% | 12(1) |
​Dividends - Paid by U.S. Corporations | 15% | 10(2) |
Dividends - Qualifying for Direct Dividend Rate | 5% | 10(2) |
Pensions | 0%* | 19(1)(a) |
Social Security | 30%** | 19(1)(b) |
*The rate applies to both periodic and lump-sum payments.
**Tax rate applies to 85% of the social security payments.
Income Earned While Temporarily Present in the US
Generally, income earned from work performed in the US would be considered US source income and would be subject to US taxation. However, the US Luxembourg tax treaty lists certain exemptions where such income is not subject to US taxes. It's important to note that these exceptions generally do not apply to U.S. expats because of the savings clause mentioned earlier. We've summarized some of these exceptions in the table below:
Income Type | Maximum Presence in U.S | Required Employer or Payer | Maximum Amount of Compensation | Treaty Article Citation |
Employee | 183 days | Any foreign resident* | No limit** | 16 |
Contractor | No limit | Any contractor | No limit*** | 15 |
Public entertainment | No limit | Any U.S. or foreign resident | $10,000 | 18 |
Teaching or research | 2 years | Any U.S. or foreign resident | No limit**** | 21(2) |
​Full-time students - remittances or allowances | 2 years*** | Any U.S. or foreign resident | No limit | 21(1) |
*Fees paid to a resident of the treaty country for services performed in the United States as a director of a U.S. corporation are subject to U.S. tax.
**The exemption does not apply if the employee's compensation is borne by a permanent establishment (or in some cases a fixed base) that the employer has in the United States.
***Exemption does not apply to the extent income is attributable to the recipient's fixed U.S. base.
****Does not apply to compensation for research work for other than the U.S. educational institution
The United States and Luxembourg have a totalization agreement in place, aimed at preventing the double taxation of income in relation to social security taxes. This agreement sets forth guidelines regarding which country's social security system a taxpayer is subject to. Consequently, employees or self-employed individuals are subject to social security taxation in only one country at a time.
State Taxes and Tax Treaties
Numerous states within the United States impose income taxes on their residents. The adherence to the Luxembourg U.S. tax treaty varies by state, some may recognize them, while others may not.
​Expert Insight: Always check with a tax professional about how state tax laws interact with the treaty, as this can vary significantly from state to state. |
Need Help Navigating the US Luxembourg Tax Treaty?
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Frequently Asked Questions
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Does Luxembourg have a totalization agreement with the US?
Do Luxembourgish citizens pay tax on US capital gains?
Article by Lewis Grunfeld, CPA
Lewis is a seasoned expert in international and U.S. expat taxation. With over 10 years of international tax experience, he specializes in applying tax treaties to benefit expats, handling complex tax scenarios and ensuring significant tax savings for his clients. Lewis's expertise in international compliance and U.S. expat tax returns has made him a trusted advisor in the expatriate community.
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