US-Australia tax treaty
What is the US-Australia tax treaty?
The US-Australian Tax Treaty is a bilateral agreement with the purpose of preventing double taxation and tax evasion between the US and Australia.
What are tax treaties?
Tax treaties are formal agreements between countries that help the individual tax authorities communicate, prevent double taxation and fiscal evasion, and assist each other by enforcing different tax laws.
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What is the purpose of the tax treaty between the US and Australia?
The US-Australian tax treaty contains provisions that help individuals avoid being taxed twice on the same income in both the US and Australia. The two leading solutions are the Foreign Earned Income Exclusion and the Foreign Tax Credit.
The US remains one of the only countries that enforces its taxation on worldwide income. So, it is a requirement and an obligation for US citizens and Green Card holders to file taxes in the US while residing in Australia.
Additionally, if your income is sourced within Australia, you will also need to lodge an Australian tax return and pay tax to the ATO. So, the tax treaty avoids this exact double taxation situation.
Do I need to report my Australian assets to the IRS?
Yes, reporting foreign assets is also required even if there is a tax treaty, it does not exempt US citizens from their FBAR (FinCEN Form 114) and FATCA (Form 8938) reporting obligations. Using tax credits and exclusions can help avoid double taxation, but reporting is still required.
What is the difference between the Foreign Tax Credit and Foreign Earned Income Exclusion?
Foreign Tax Credits (FTCs) work by lowering your income tax directly, reducing the tax you might owe. Certain FTCs are refundable and can even increase your tax refund if you’re eligible for one.
On the other hand, the Foreign Earned Income Exclusion (FEIE) lowers your taxable income. This option reduces the amount the IRS will use to calculate your tax, which can lessen or eliminate your tax bill altogether. It allows you to exclude a certain amount of your foreign-earned income from your tax return.
For tax year 2024, the maximum exclusion is US$126,500 per person and US $253,000 for married filing jointly.
What’s the better option for US citizens living in Australia?
For US citizens living in Australia, claiming Foreign Tax Credits is often the better choice. Because the tax rate is higher in Australia than in the US, claiming the FTC will typically eliminate any US tax you might owe.
The FTC route offers more flexibility than FEIE and has no lock-in requirements or limits on US travel. You can also carry unused tax credits forward and apply them to your next 10 years of tax returns. Even so, it’s always important to consider your unique financial situation and your eligibility for these provisions before choosing one or the other.
How does the treaty address dual residency?
The US and Australia have quite different definitions of residency, and because of this, an individual may qualify as a resident in both countries. The residency status of an individual is determined under the US-Australia tax treaty, which affects tax obligations and benefits.
The treaty includes a tie-breaker test to determine which country holds the tax priority to avoid issues and complications.
Need help with your US tax obligations in Australia? We got you covered.
What’s inside the tie-breaker test?
The tie-breaker test applies sequentially, moving to the next criterion only if the previous one does not resolve the residency conflict. These are as follows:
- Permanent home: This is to see whether the individual has been deemed a resident of the country where they have a permanent home, which can be a house, apartment, or other dwelling available to the individual on a long-term basis.
- Habitual abode: If the individual has a home in both or neither country, the treaty considers where they usually live. This means where they spend more time or have a regular presence.
- Center of vital interests: If the individual has a habitual abode in both or neither country, the treaty then looks at where their personal and economic ties are stronger, often called their “center of vital interests.” This includes factors like family, social, professional, and economic connections.
If these questions end in yet another tie, the tax authorities from each country will settle it between themselves until they reach a mutual agreement.
Do I need to pay social security for both countries?
Because Australia and America have unique social security systems, a Totalization Agreement was designed to prevent taxpayers from contributing to both. The agreement also covers the Australian Super Guarantee contributions, as superannuation is a major, if not the primary, source of retirement income for many Australians.
It sets guidelines about which country’s social security system applies to an employee. This ensures that employees and employers are only taxed by one system at a time, protecting workers’ rights and ensuring they receive their entitled benefits, no matter where they live or work, between the two countries.
Is my superannuation taxable in the US?
Yes, the IRS generally perceives distributions from your super as taxable income. The type of fund also determines how much tax you will pay. Some funds, such as an SMSF, can lead to higher US taxes on earnings and distributions.
There are complexities involved in the taxation of Australian superannuation, and on top of that, there are also treaty implications like the saving clause, which could heavily impact the taxation of US expats residing in Australia.
What is the savings clause?
The Savings Clause is a standard provision in most US tax treaties, including the US-Australia treaty. This clause preserves the US government’s right to tax its citizens as if the treaty didn’t exist, which means that US expats must still report and pay US taxes on their Australian income.
So, the savings clause within the treaty has a huge impact on the taxation of US citizens and Green Card holders in Australia.
Will my passive income from the US be taxed in Australia?
Yes, your passive income from the US may be taxed in Australia, depending on the type of income and the application of the US-Australia tax treaty. However, the treaty and Australian tax rules aim to avoid double taxation, typically allowing tax credits for US taxes paid.
If you receive US dividends, interests, capital gains, or rental income, they are included in your assessable income in Australia. However, you can usually claim a foreign tax credit for the US withholding tax.
Will my property in Australia be taxed in the US?
Yes, generally, if your property in Australia generates income, then you need to report it to the IRS and pay taxes on real property income.
The taxation of real property income depends on the classification of property you own. You will either pay tax on ordinary income if you have rental properties or be subject to capital gains tax or US estate tax.
You can always claim foreign credits and deductions relating to your property expenses to minimize your tax liability and avoid double taxation.
Will the information for my tax return be shared between both countries?
Because of the tax treaty, both the ATO and the IRS have the ability to share their tax information, although it’s unusual for them to do so without reason. That said, trying to hide or avoid your tax obligations in either location could result in hefty fines or penalties for non-compliance. People do get caught and the consequences are harsh.
It’s always best to stay on the safe side and report all of your local and international income. When it comes to saving on your tax bill and utilizing the US-Australian tax treaty to your benefit, qualified tax professionals can help.
