The dangerous implications of claiming a benefit unde r the U.S.-Israel tax treaty Many U.S. tax practitioners will correctly advise their non-resident alien (NRA) clients residing outside the U.S. to enjoy reduced treaty tax rates by filing Form 8843. For example, if an NRA residing in Israel receives passive interest or dividends from the U.S., absent the above treaty, the U.S. tax rate will be 30%. However, under the treaty, the tax rates can be as low as 10% and 12.5% respectively. In this case, making the treaty election by filing Form 8843 makes sense. However, what if the taxpayer is a U.S. Person – i.e. a U.S. citizen or Green Card holder residing in Israel? In the event of a U.S. Citizen, the treaty savings clause states that the U.S. may tax its citizens as if the treaty had not come into effect. Does this mean that a U.S. citizen may not enjoy any treaty benefits? In 2016, in the case of Cole v. I.R.S., the U.S. tax court ruled that as to capital gains, the savings clause prevails. Thus a U.S. citizen residing in Israel cannot enjoy the treaty benefits as can an Israeli-based NRA. Does this ruling govern all aspects of the treaty? Unclear. But the situation is much more complex and dangerous when it comes to green card holders. Note that Form 8843 states that "If the taxpayer is a dual-resident taxpayer and a long-term resident, by electing to be treated as a resident of a foreign country for purposes of claiming benefits under an applicable income tax treaty, the taxpayer will be deemed to have expatriated pursuant to section 877A." What does this mean? Let us break down this sentence into components. First, we are dealing with a dual resident – i.e. a green card holder who resides in Israel. Second, a long-term resident is one who has held a green card holder for eight of the previous 15 tax years. And 877A deals with the exit tax. So in essence, the above clause states that if a long term green card holder residing in Israel makes a Form 8843 treaty election to be treated as an Israeli, this inadvertently triggers the exit tax!! How are the 8 and 15 years counted? When does the counting start? Is there a way to stop the counting? Obviously, as to a potential long term green card holder, these questions must be carefully taken into account BEFORE the person makes the election, or even files a 1040NR, which can also be deemed an expatriation event. And as to green card holders approaching the 8 year mark, what planning should be done? Section 877(e)(2) states that in counting years, "an individual shall not be treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country for the taxable year under the provisions of a tax treaty between the United States and the foreign country and does not waive the benefits of such treaty applicable to residents of the foreign country." While the language is very hard to understand, failure to understand how this clause can be used for your client's beenfit can have disastrous implications – both with regard to exit tax and the following discussion. An inadvertent exit tax can be bad, but the little known Section 2801 of the code is much worse. Section 2801 imposes a 40% flat tax on any gifts that an expat (including a long-term resident who expats by way of an 8843 election) gifts or leaves at death to any U.S. Citizen. And this tax is for life and applies to assets accumulated after the expatriating act!

To summarize, the seemingly innocent treaty election of Form 8843 can have devastating impact on green card holders. Care should be taken in claiming a treaty benefit when the client is a green card holder residing outside the U.S. This document does not constitute legal advice. If you have any questions, please contact us. Monte Silver is a U.S. tax attorney residing in Israel. He previously worked for the Estate & Gift Division of the IRS and the U.S. Tax Court