What Are the Rules of the US-Italy Tax Treaty?

The US-Italy tax treaty is a bilateral agreement to allocate taxing rights between the two nations, preventing the same income from being taxed twice. This framework fosters economic cooperation by providing clear rules for individuals and businesses operating across borders.

Determining Treaty Eligibility

To access treaty benefits, a person must be a “resident” of either the United States or Italy, as defined by each country’s domestic laws. The U.S. may consider an individual a resident based on a green card or the substantial presence test, while Italy may use criteria like local registration. An individual can sometimes meet both countries’ residency requirements, creating a dual-residency situation.

To resolve dual-residency cases for individuals, the treaty establishes a sequence of “tie-breaker” rules to assign a single country of residence for tax purposes. The treaty uses the following tests in order:

• The location of a “permanent home” available to the individual.
• The “center of vital interests,” analyzing where personal and economic ties are closer, if a permanent home exists in both countries.
• The “habitual abode,” or the country where they spend more time.
• Citizenship, as the final deciding factor.

The treaty’s “saving clause” allows both the U.S. and Italy to tax their own citizens and residents as if the treaty did not exist. This means a U.S. citizen in Italy remains subject to U.S. tax on worldwide income. However, important exceptions preserve certain benefits, such as for social security payments, ensuring only one country taxes that specific income.

Tax Treatment of Specific Income Types

The treaty provides specific rules for different income categories. To prevent double taxation, the country of residence may tax the income while the source country offers an exemption or a reduced rate. The country of residence will then allow a foreign tax credit for taxes paid to the source country.

Pensions, Annuities, and Social Security

Private pensions and annuities are taxable only in the recipient’s country of residence. For instance, a U.S. resident receiving a private pension from an Italian source would only pay U.S. tax on it. Social security payments follow this same residence-based rule. This provision is a notable exception to the saving clause, so a U.S. citizen in Italy receiving U.S. Social Security finds it taxable only by Italy.

Dividends and Interest

The treaty reduces the withholding tax a country can impose on dividends and interest paid to a resident of the other country. For dividends, the rate is capped at 15%, with a lower 5% rate if the owner is a company that held at least 25% of the paying company’s voting stock for the prior 12 months. For interest income, the withholding tax rate is limited to 10%.

Business Profits

A business’s profits are taxable in its country of residence unless it operates through a “permanent establishment” (PE) in the other country. A PE is a fixed place of business like an office or factory, or a construction site lasting more than twelve months. If a U.S. company has a PE in Italy, Italy may tax the profits from that PE. A subsidiary’s existence alone does not create a PE for its parent company.

Income from Employment

Income from employment is taxed in the country where the work is performed. However, the treaty’s “183-day rule” provides an exemption from source-country tax if three conditions are met. The employee’s stay must not exceed 183 days in a tax year, their employer cannot be a resident of that country, and the payment is not borne by a PE of the employer in that country. If all conditions are met, the income is taxable only in the employee’s country of residence.

Capital Gains

The rules for taxing capital gains depend on the property type. Gains from selling real property may be taxed by the country where it is located. For example, Italy can tax the gain from a U.S. resident selling a vacation home in Italy. For gains from other property, like stocks or bonds, the taxing right rests with the seller’s country of residence.

Claiming Treaty Benefits

To claim benefits under the treaty, taxpayers must disclose their position to the tax authorities. This is done by gathering the correct information and filing the appropriate forms with a tax return. The process ensures the claim is properly documented.

Information and Forms Needed for Disclosure

The primary document for claiming treaty benefits on a U.S. tax return is Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701. To complete this form, a taxpayer must identify the specific treaty article providing the benefit, summarize the supporting facts, and state the nature and amount of the income involved.

Filing Your Tax Return

Form 8833 must be attached to the taxpayer’s annual U.S. income tax return, such as Form 1040 for an individual. A separate Form 8833 is required for each distinct treaty-based position taken. Failing to file a necessary Form 8833 can result in a penalty of $1,000 for individuals and up to $10,000 for C corporations for each failure.