A formal agreement between two countries that reduces or eliminates double taxation on income earned across borders.
What is a Tax Treaty?
A Tax Treaty is a bilateral agreement between two countries that defines how income earned in one country by a resident of the other should be taxed. The goal is to prevent double taxation—that is, being taxed by both countries on the same income—and to clarify which country has the primary right to tax certain types of income, such as dividends, interest, royalties, or business profits.
The United States has tax treaties with over 60 countries, including Canada, the U.K., Germany, India, Turkey, and others. These treaties are especially important for non-U.S. persons with U.S. business interests or investments, as they can significantly reduce withholding tax rates and offer specific exemptions.
Without a treaty, the default U.S. withholding tax on income like dividends, interest, or royalties paid to foreign persons is 30%. However, under a tax treaty, that rate may be reduced or eliminated entirely. For example:
- Dividends may be reduced to 15% or 5%
- Interest payments may be reduced to 0%
- Royalty payments may be partially or fully exempt
In addition, treaties may offer protection against taxation on business profits, unless the foreign person has a “permanent establishment” in the U.S. (like an office or fixed place of business).
To claim treaty benefits, a foreign individual or entity typically must:
- Be a resident of a country with a tax treaty with the U.S.
- Provide a valid U.S. tax form such as Form W-8BEN (for individuals) or Form W-8BEN-E (for entities) to the withholding party (e.g., a U.S. client, payment processor, or bank)
There are important considerations when it comes to tax treaties. First, tax treaties do not override domestic tax obligations. For example, income that is considered effectively connected to a U.S. trade or business (ECI) may still be fully taxable in the U.S., even if a treaty is in place. Additionally, treaty benefits vary significantly by country, as each agreement has its own terms, definitions, and limitations. Finally, the IRS may deny treaty benefits if the taxpayer fails to submit the required documentation (such as Form W-8BEN or W-8BEN-E) or does not meet the treaty’s residency and eligibility criteria.
In summary, a tax treaty is a legal agreement between the U.S. and another country that helps reduce or eliminate cross-border double taxation. For non-U.S. founders, investors, and freelancers doing business with U.S. entities or earning U.S. income, understanding whether a treaty exists—and how to apply its benefits—is essential to avoid unnecessary tax withholding and stay compliant with IRS rules.
