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Navigating the complexities of the US-China Tax Treaty is essential for Americans residing in China and Chinese nationals with income sourced from the US. This in-depth guide offers a clear breakdown of the treaty’s provisions, helping you understand its impact on personal taxation and how it aids in avoiding double taxation.
Signed in 1987, the US-China Tax Treaty outlines the tax obligations for income that may be taxable under US and Chinese laws. The treaty addresses key areas, including avoiding double taxation, residency tie-breakers, and the taxation of various income types, such as business profits, dividends, interest, pensions, and capital gains. This guide highlights significant aspects of the treaty that are particularly relevant to taxpayers.
The treaty ensures that income earned in one country by residents or citizens of the other is not taxed twice. US citizens and residents can claim a foreign tax credit for taxes paid to China on Chinese-sourced income against their US tax liability. Similarly, China offers a credit for US taxes paid on US-sourced income against Chinese tax liabilities.
Example: Chen Wei, a US citizen living in Shanghai, earns an annual salary of $80,000 and pays $25,000 in Chinese taxes. His US tax liability for this income is $22,000. Using the treaty’s double taxation relief, Chen can claim the $25,000 paid in Chinese taxes as a credit against his US tax obligation, reducing his US tax liability to zero and generating a $3,000 surplus credit that can be carried forward to future tax years.
The treaty’s “Savings Clause” allows the US to tax its citizens according to its laws, regardless of the treaty’s provisions. This means the treaty’s benefits and reductions do not apply to US citizens living in China.
Example: Wang Huan, a US citizen working in Beijing for an American tech company, must report her income to the US despite the treaty’s provisions that might otherwise exempt such income. However, to avoid double taxation, she can take advantage of the foreign-earned income exclusion or foreign tax credits for taxes paid in China.
MSA Expert Tip: US citizens must understand the exclusions and implications of the Savings Clause in all tax treaties to determine accurately which tax benefits they can utilize.
Both the United States and China have their criteria for determining tax residency. Someone can meet the residency requirements of both countries simultaneously. To resolve dual residency issues, the US-China Tax Treaty includes tie-breaker rules that help determine an individual’s tax residency based on factors such as permanent home, center of vital interests, habitual abode, and nationality. If these criteria do not resolve the issue, the competent authorities of both countries will make a mutual agreement.
Passive income from US sources, such as interest, dividends, and pensions, is generally taxed at 30% for non-resident aliens. The US-China Tax Treaty reduces these rates or exempts certain types of income for Chinese residents. However, due to the Savings Clause, these benefits generally do not apply to US citizens.
| Income Type | Tax Rate | Treaty Article Citation |
|---|---|---|
| Interest | 10% | 10(2) |
| Dividends – Paid by US Corporations | 10% | 9(2) |
| Dividends – Qualifying for Direct Dividend Rate | 10% | 9(2) |
| Pensions | 0%* | 17(1) |
| Social Security | 30%** | 17(2) |
*Pension provision does not apply to annuities. **Social Security tax rate applies to 85% of the payments received, effectively reducing the tax rate.
The US-China Tax Treaty provides exemptions for income earned from work performed in the US under specific conditions. However, due to the Savings Clause, these exemptions generally do not apply to US citizens.
| Income Type | Maximum Presence in US | Required Employer or Payer | Maximum Compensation | Treaty Article Citation |
|---|---|---|---|---|
| Employee* | 183 days | Any foreign resident* | No limit | 14 |
| Contractor | 183 days*** | Any contractor | No limit | 13 |
| Scholarship or fellowship grant | No limit | Any US or foreign resident | No limit | 20(b) |
| Teaching**** | 3 years | US educational or research institute | No limit | 19 |
| Full-Time Students – remittances or allowances | No limit | Any foreign resident | No limit | 20(a) |
| Full-Time Students – Compensation during training | No limit | Any US or foreign resident | $5,000 | 20(c) |
*Exemption does not apply if the employee’s compensation is borne by a permanent establishment in the US. **Does not apply to fees paid to a director of a US corporation. ***Exemption does not apply to income attributable to the recipient’s fixed US base. ****Does not apply to compensation for research work primarily for private benefit.
Unfortunately, the US and China do not have a totalization agreement relevant to self-employment income. Such an agreement would help prevent the double taxation of self-employment income concerning social security taxes. Without this agreement, a self-employed US citizen working in China is subject to social security taxes in both countries.
Numerous states within the United States impose income taxes on their residents. State adherence to federal US tax treaty provisions varies; some may recognize them, while others may not. It is crucial to check with a tax professional regarding how state tax laws interact with the treaty, as this can vary significantly from state to state.
MSA Expert Insight: Always consult with a tax professional about how state tax laws interact with the treaty to ensure compliance and optimize tax benefits.
At MSA, we specialize in helping companies stay compliant with their taxes. Contact us today, and let our tax experts simplify your life and taxes.
