How the U.S.-Spain Tax Treaty Affects You

The United States and Spain share a bilateral tax treaty to address international taxation for individuals and companies with financial ties to both nations. This agreement was updated by a protocol that took effect in late 2019. The treaty’s primary purpose is to prevent the same income from being taxed by both countries and to facilitate cooperation between their tax authorities. By establishing clear rules for taxing rights, the accord fosters investment and trade by providing a more predictable tax environment.

Determining Tax Residency

To access the benefits of the U.S.-Spain tax treaty, an individual must be considered a “resident” of one or both countries for tax purposes. In the United States, residency is established if you are a U.S. citizen, a green card holder, or if you meet the “substantial presence test.” This test involves being physically present in the U.S. for a specific number of days over a three-year period.

Spain determines tax residency based on physical presence. An individual is considered a Spanish tax resident if they spend more than 183 days in the country during a calendar year. Having one’s main center of economic or personal interests in Spain can also lead to Spanish tax residency. Since each country applies its own laws, it is possible for an individual to be considered a tax resident of both the U.S. and Spain simultaneously.

When an individual is a resident of both countries, the treaty provides “tie-breaker” rules to assign a single country of residence for treaty purposes. These rules are applied sequentially, starting with where the individual has a “permanent home” available. If a permanent home is available in both countries, the next test examines the “center of vital interests” by looking at where personal and economic ties are closer.

If the center of vital interests cannot be determined, the subsequent test is the “habitual abode,” which looks at where the person more frequently lives. Should this test also be inconclusive, the final tie-breaker rule is citizenship. The outcome establishes which country has the primary right to tax the individual’s worldwide income.

Methods for Relieving Double Taxation

Once tax residency is established, the treaty employs specific mechanisms to prevent double taxation. The treaty outlines how each country must provide relief when both have a right to tax the same income, ensuring that income is not fully taxed by two different jurisdictions.

The United States provides relief from double taxation primarily through the foreign tax credit. A U.S. citizen or resident is subject to U.S. tax on their worldwide income, but when they pay income tax to Spain on Spanish-source income, they can claim a credit for those taxes on their U.S. tax return. This credit directly reduces U.S. income tax liability.

Spain utilizes a similar approach for its residents. When a Spanish resident earns U.S.-source income that is also taxable in the United States, Spain will provide relief. This is often done through a credit for the U.S. taxes paid or through an exemption method, where the U.S.-source income is excluded from the Spanish tax base.

Treaty Rules for Common Income Types

Pensions, Annuities, and Social Security

The U.S.-Spain tax treaty sets forth specific rules for retirement income. For private pensions and similar remuneration, the rule is that they are taxable only in the individual’s country of residence. This means a U.S. resident receiving a private pension from a Spanish source would only pay U.S. tax on that income.

In contrast, government-paid pensions and Social Security benefits are treated differently. Payments made under the social security legislation of one country are taxable only by that country. For example, U.S. Social Security benefits paid to a resident of Spain are subject to tax only in the United States. Pensions paid by one of the governments for past public service are also taxed only by that government’s country.

Dividends and Interest

The treaty provides for reduced tax rates on investment income. When a resident of one country receives dividends from a company in the other (source) country, the source country may impose a withholding tax, but the rate is capped at 15%. The rate is reduced to 5% if the recipient is a company that owns at least 10% of the paying company’s voting stock.

In some cases, the withholding tax is eliminated entirely, such as for dividends paid to a qualifying parent company that has held at least 80% of the voting stock for a year, or for dividends paid to pension funds. For interest income, the withholding tax on interest payments is eliminated in most situations. A 10% rate may apply in limited circumstances, such as for certain types of contingent interest.

Capital Gains

The taxation of capital gains is addressed, with the rule being that gains are taxable only in the country where the seller is a resident. For instance, if a resident of Spain sells shares of a U.S. company, any resulting capital gain would be taxed only in Spain.

An exception exists for gains from the sale of real property. The treaty allows the country where the real property is located to tax any gains from its sale. This right also extends to taxing gains from the sale of shares in a company if its value is primarily derived from real property located in that country. For example, if a U.S. resident sells a vacation home in Spain, Spain retains the right to tax the capital gain.

Income from Employment

For income earned from employment, the treaty establishes that wages and salaries are taxed in the country where the work is physically performed. If a U.S. resident works for a period in Spain, Spain has the right to tax the income earned during that time.

The treaty includes the “183-day rule,” which provides an exception. Employment income may be taxed only in the individual’s country of residence if three conditions are met:

• The employee is present in the other country for less than 183 days in any 12-month period.
• The remuneration is paid by an employer who is not a resident of the other country.
• The remuneration is not borne by a permanent establishment that the employer has in the other country.

The Saving Clause for US Citizens

A feature of all U.S. tax treaties is the “Saving Clause.” This provision allows the United States to tax its citizens and certain former citizens as if the treaty did not exist. This means that even if the treaty assigns the exclusive right to tax a particular type of income to Spain, the U.S. can still tax that income if the recipient is a U.S. citizen.

Because of the Saving Clause, a U.S. citizen living in Spain must continue to report their worldwide income to the IRS. For example, if a U.S. citizen residing in Spain earns income from a Spanish employer, the Saving Clause overrides the treaty rule and allows the U.S. to also tax that income. This reaffirms the U.S. system of citizenship-based taxation.

The primary relief from double taxation for a U.S. citizen in this situation is the foreign tax credit. Relief is obtained by claiming a credit on their U.S. return for the income taxes they have paid to Spain. This mechanism ensures that while the income is reported in both countries, it is not taxed twice at its full rate.

The Saving Clause does have specific exceptions where treaty benefits are preserved for U.S. citizens. These exceptions are listed in the treaty and include rules related to Social Security payments, child support, and certain pensions for government service. For these specific income types, the treaty rules will override U.S. domestic law even for U.S. citizens.