by John Anthony Castro, J.D., LL.M.
As of today, the prevailing wisdom is that, due to treaty “Saving Clauses,” U.S. citizens are generally prohibited from enjoying most of the benefits under income tax treaties. As history has proven, however, the prevailing wisdom is not always correct, and this article sets out to correct the prevailing opinion.
Code section 6114(a) requires any person relying on an income tax treaty to disclose such position on his or her federal income tax return “in such manner as the Secretary may prescribe.” The Secretary has prescribed that this is to be accomplished by filing IRS Form 8833 along with the taxpayer’s U.S. federal income tax return. A separate Form 8833 is required for each treaty-based return position taken by the taxpayer. If the treaty position is based on residency and results in no taxation whatsoever, then Form 8833 must be filed along with a federal income tax return that only includes the taxpayer’s name, address, taxpayer identification number, and signature under the penalty of perjury. If a taxpayer “fails in a material way to disclose one or more” treaty-based return positions, then a penalty is imposed on each separate payment of income or article of income even if “received from the same” payor. For C Corporations, there is a penalty of $10,000 for each non-disclosed treaty-based return position. For all others, it’s a $1,000 penalty for each non-disclosure.
Section 6114(b) provides that the “Secretary may waive the requirements of subsection (a) with respect to classes of cases for which the Secretary determines that the waiver will not impede the assessment and collection of tax.” To put that more straightforward, Treasury is permitted to promulgate regulations waiving the disclosure requirement on Form 8833. In other words, there are some treaty positions that are not required to be reported on Form 8833.
However, as mentioned in the opening paragraph, the U.S. negotiates a “saving clause” that exists in every U.S. income tax treaty with the exception of the U.S. income tax treaty with Pakistan. The saving clause allows the IRS to disregard treaty benefits claimed by U.S. citizens and treaty residents. However, the Saving Clause does not automatically apply as a matter of law; it’s merely a reserved, permissive right of the U.S. that must be affirmatively asserted. Furthermore, the U.S. Tax Court explained in Savary v. Commissioner that claims of treaty benefits made by U.S. citizens are not subject to the 20% accuracy-related penalty because U.S. citizens are not prohibited from claiming treaty benefits; they are merely subject to being disregarded if the IRS asserts the Saving Clause. The IRS now agrees with the U.S. Tax Court and conceded the issue in 2012 in the Ready v. Commissioner case.
When all of this is combined with treaty-based positions that are exempt from disclosure, it allows for U.S. citizens to make claims to treaty benefits that are not required to be disclosed. The IRS cannot affirmatively assert the Saving Clause if it is unaware of the treaty claim. This unintended result creates a situation that squarely fits the classical definition of the term “loophole.” The unintended yet lawful result is that U.S. citizens can take a substantial number of undisclosed treaty positions so long as those treaty positions fit into one of the exceptions in the Treasury regulations.
Treasury regulations section 301.6114-1 sets out the rules governing the manner in which treaty positions are disclosed, the specific form to be used (i.e., Form 8833), and the various positions for which reporting is specifically waived. The income-based positions for which reporting on Form 8833 is specifically waived includes treaty positions that exempt salaries and wages from dependent personal services, private or public pensions, annuities, social security, or income generated by artists, athletes, students, trainees, or teachers; regardless of the amount. Again, there is no limit on the amount that can be excluded; it could be $100 million. More importantly, nothing in the regulations prevents U.S. citizens from taking these positions, and this has no effect on the statute of limitations.
To put all of this into perspective, let’s use an example involving a high-earning individual. Russia has a flat personal income tax rate of only 13%. Let’s assume you have a client who is a dual U.S.-Russian citizen living and working in Moscow earning a salary of $2,500,000 USD. Like most practitioners, you would advise the client that, although she has already paid 13% to the Russian tax authorities, she also has to report and pay tax on the income in the U.S. offset only by a foreign tax credit for that 13% already paid. Assuming the client’s effective U.S. tax rate is 25%, that’s an additional tax of $300,000. Based on your newfound knowledge in this article, you can now take a Silent Treaty Position under Article 14, Paragraph 1, which does not have to be disclosed on Form 8833. In the aforementioned example, it would save the client $300,000. Even if the taxpayer is not from a lower tax country, taking a Silent Treaty Position could both make compliance substantially easier as well as generate some decent tax savings.
Let’s look at another compelling example involving musicians and artists. Some treaties do not specifically address entertainers. In those treaties, such as the U.S.-Russia Income Tax Treaty, entertainers would be exclusively taxable in their country of tax residency pursuant to Article 13 (Independent Personal Services) with no limit of the amount. Russia allows for individuals to voluntarily register as tax residents. Doing so would subject said individual to Russian taxation, but it would also make that individual eligible for benefits under the U.S.-Russia Income Tax Treaty. The earnings could be paid to an account outside of Russian to avoid capital export restrictions. As a result, the individual’s income would be taxed at only 13% with no additional U.S. tax.
You can read about these advanced topics and more in our book International Taxation in Plain English, which is available on Amazon Prime: click here.If you think you could benefit from a Silent Treaty Position, contact an international tax attorney at Castro & Co. schedule a free consultation. Call (833) 227-8761 or complete our online form.
 See Green v. C.I.R., 95 T.C.M. 1512 (2008), aff’d, 322 F. App'x 412 (5th Cir. 2009) (even if informal documents constitute an income tax return, a treaty position absolutely requires an IRS-issued Form 8833).
 See Treas. Reg. § 301.6712-1(a).
 IRC § 6712.
 Treas. Reg. § 301.6114-1(a)(1)(ii).
 The Technical Explanation of Article 1, Paragraph 4, of the U.S. Model Income Tax Treaty states that for “purposes of the Saving Clause, ‘residence’ is determined under Article 4 (Residence).”
 For example, under the U.S.-U.K. Income Tax Treaty, it states that a “Contracting State may tax its [treaty] residents… and… citizens, as if this Convention had not come into effect.”
 See Savary v. C.I.R., T.C. Summ.Op. 2010-150, Docket No. 6839-09S (T.C. 2010).
 See Ready v. C.I.R., T.C. Summ.Op. 2012-12 (T.C. 2012).
 See Treas. Reg. § 301.6114-1(c)(1)(iv).
 See IRC § 6501(c)(8)(A).