Understanding the US Spanish tax treaty is crucial for American living in Spain and to Spanish individuals who have U.S. source income. This comprehensive 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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Introduction to the US Spain Tax Treaty
The US Spain tax treaty, originally signed in 1990, 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, residency tie-breakers and discusses taxation of various forms of income, including business profits, dividends, interest, pensions, and capital gains. This guide will focus on some of the key aspects of the treaty that hold particular significance.
Relief of Double Taxation
The Spanish US 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. Specifically, the treaty allows U.S. citizens and residents to claim a foreign tax credit for the income tax they pay to Spain against their U.S. tax obligations. Conversely, Spain offers a credit for U.S. taxes paid against the Spanish tax liabilities of its residents for U.S. sourced income.
Example
Alejandro Martínez, a U.S. citizen living in Seville, earns an annual salary of $80,000. In Spain, he pays $25,000 in taxes for the year. Alejandro's U.S. tax liability for this income amounts to $22,000. Thanks to the relief of relief of double taxation provision of the tax treaty, he is entitled to claim a foreign tax credit on his US taxes. Alejandro applies the $25,000 he paid in Spain 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 applicable for carryover to subsequent tax years.
The Savings Clause
The Spanish US tax treaty contains a "savings clause" which allows the U.S. to impose taxes on its citizens according to its own laws as if the treaty did not exist. As a result of this clause, the majority of the benefits and reductions offered by the treaty do not apply to U.S. citizen expats.
Example of the Savings Clause Nullifying a Tax Treaty Benefit
Sara Ramírez, a U.S. citizen and software developer, lives and works in Valencia, Spain for an American biotech company. She conducts all her work in Spain and maintains no physical establishment in the U.S. Despite the Spain US tax treaty exempting such income from U.S. tax (since there's no permanent establishment), the savings clause overrides this, requiring Sara to declare and pay U.S. taxes on her income. Nevertheless, Sara can take advantage of foreign earned income exclusions or tax credits for the taxes paid in Spain 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 US Spain Tax Treaty to accurately determine which tax benefits they can utilize. |
Tax Residency and the Tie-Breaker Rules
The United States and Spain each 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 residency could cause, the Spain U.S. 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.
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 Spain 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 taxed at a flat rate of 30% if earned by a non-resident alien. However, the US Spain tax treaty may lower this rate or totally exempt 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 | Treaty Article Citation |
Interest | 0% | 11(2) / PV |
Dividends - Paid by U.S. Corporations | 15% | 10(2) / PIV |
Dividends - Qualifying for Direct Dividend Rate | 5% | 10(2) / PIV |
Pensions and Annuities | 0% | 20(1)-(2) |
Social Security and Alimony | 30%* | 20(1)(b) |
*Tax rate applies to 85% of the social security payments you receive from the U.S. Government. Therefore, the actual tax rate you pay on your total social security payments is 85% of the rate listed in the table.
Personal Service 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 Spain 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 US citizens 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 | 19 |
Full-Time Students - remittances or allowances | 5 years | Any foreign resident | No limit***** | 22(1) |
Full-Time Students - Compensation during training | 5 years | Any U.S. or foreign resident | $5,000**** | 22(1) |
Full-Time Students - Compensation while gaining experience | 12 consecutive months | Spanish Resident | $8,000**** | 22(2) |
Scholarship or fellowship grant | 5 years | Any U.S. or foreign resident | No limit**** | 22(1) |
*The exemption does not apply if the employee's compensation is borne by a permanent establishment that the employer has in the United States. **Fees paid for services performed in the United States as a director of a U.S. corporation are subject to U.S. tax.
***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 primarily for private benefit.
Totalization Agreement
The United States and Spain have a totalization agreement in place, which is designed to avoid double taxation of their income with respect to social security taxes. It establishes clear rules about which country's social security system covers the employee. As a result, employees and their employers can only be taxed by one country's social security system at a time.
State Taxes and the US Spain Tax Treaty
Numerous states within the United States impose income taxes on their residents. The adherence to the Spanish U.S. tax treaty provisions 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 Spain Tax Treaty?
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Frequently Asked Questions
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Authored by Lewis Grunfeld, CPA
Lewis is a seasoned expert in international and U.S. expatriate 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.
Thank You.
I‘ve been looking for confirmation of what my accountant in the U.S. has told me. He informed me that as a U.S. citizen residing in Spain, all my income tax derived in the U.S. and payable in Spain will serve as a tax credit in the U.S. And since the tax in Spain is greater than the tax in the U.S. that tax credit would wipe out the total amount of tax owed in the I.R.S.