United States-Republic of Korea Income Tax Treaty

United States-Republic of Korea Income Tax Treaty

US Korea Tax Treaty

The US Korea Tax Treaty is a robust international tax treaty between the United States and Republic of Korea. The United States has entered into several tax treaties with different countries across the globe — including Korea. There are many US taxpayers who are originally from Korea and/or still maintain offshore accounts, assets & investments and/or generate income from Korea. The United States and Korea entered into a tax treaty nearly 50-years ago. The purpose of the tax treaty is so Taxpayers can determine what their tax liability is for certain sources of taxable income. While the treaty is not the final word in how items of income will be taxed, it does help residents better understand how either the IRS and/or Korea will tax certain sources of income – and whether or not the saving clause will further impact the outcome. Let’s review the basics of the United States-Republic of Korea Income Tax Treaty – and how the income tax treaty between US and Korea works.

US Korea Income Tax Treaty Basics

In general, the default position is that a Taxpayer who is a US person such as a US Citizen, Legal Permanent Resident, or Foreign National who meets Substantial Presence Test is taxed on their worldwide income. This would also include income that is being generated in Korea, and may be tax-free or exempt under the tax rules of Korea — unless an exception, exclusion or limitation applies (such as with pension).

Saving Clause in US Korea Tax Treaty

As we work through the United States-Republic of Korea Tax Treaty, one important thing to keep in mind is the saving clause. The saving clause is inserted in tax treaties in order to limit the application of the treaty to certain residents/citizens. With the saving clause, each country retains the right to tax certain citizens and residents as they would otherwise tax under general tax principles in their respective countries — absent the tax treaty taking effect.

What does the Saving Clause Say?

      • (4) Notwithstanding any provisions of this Convention except paragraph (5) of this Article, a Contracting State may tax a citizen or resident of that Contracting State as if this Convention had not come into effect.

Limitations on the Saving Clause 

Despite any limitation created by the saving clause, certain portions of the tax treaty are still immune from the saving clause — which means the tax treaty will stand on issues involving the following tax matters:

The provisions of paragraph (4) shall not affect:

(a) The benefits conferred by a Contracting State under

      • Article 5 (Relief from Double Taxation)

      • Article 7 (Nondiscrimination)

      • Article 24 (Social Security Payments), and

      • Article 27 (Mutual Agreement Procedure); and

(b) The benefits conferred by a Contracting State under

      • Article 20 (Teachers)

      • Article 21 (Students and Trainees), and

      • Article 22 (Government Functions), upon individuals who are neither citizens of, nor have immigrant status in, that Contracting State.

ARTICLE 23 Private Pensions and Annuities

      • (1) Except as provided in Article 22 (Governmental Functions), pensions and other similar remuneration paid to an individual who is a resident of one of the Contracting States in consideration of past employment shall be taxable only in that Contracting State.

      • (2) Alimony and annuities paid to an individual who is a resident of one of the Contracting States shall be taxable only in that Contracting State.

      • (3) The term “pensions and other similar remuneration”, as used in this Article, means periodic payments made

        • (a) by reason of retirement or death in consideration for services rendered, or (b) by way or compensation for injuries received in connection with past employment.
      • (4) The term “annuities”, as used in this Article, means a stated sum paid periodically at stated times during life, or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

      • (5) The term “alimony”, as used in this Article, means periodic payments made pursuant to a decree of divorce, separate maintenance agreement, or support or separation agreement which is taxable to the recipient under the internal laws of the Contracting State of which he is a resident.

What does this Mean?

The general rule is that subject to Article 22 (Government Functions), when a Taxpayer resides in one country and receives pension from employment – only that country of Residence can collect tax. In other words, if a US person resides in the Korea and receives payments for services rendered, only Korea would be the only contracting state to have the opportunity to tax the taxpayer. The same rule applies to annuities and alimony.

It should be noted that there is a distinction between paragraph 1, which refers to pension for past employment and paragraph 2 which refers to annuities but does not necessarily need to be the result of employment.

Saving Clause

The saving clause may impact the application of this rule, since it was not identified in paragraph four of Article 6.

Social Security Payments: ARTICLE 24 of US Korea Tax Treaty

      • Social security payments and other public pensions paid by one of the Contracting States to an individual who is a resident of the other Contracting State (or in the case of such payments by Korea, to an individual who is a citizen of the United States) shall be taxable only in the first-mentioned Contracting State.

      • This Article shall not apply to payments described in Article 22 (Governmental Functions).

What does this Mean?

It means that when it comes to Social Security and other public pensions, they will only be taxed in the first mentioned state. In other words, if the United States pays Social Security to a US person who resides Korea, then only the United States will be able to tax that Social Security income.

Income from Real Property: ARTICLE 24 of US/Korea Tax Treaty

      • (1) Income from real property, including royalties and other payments in respect of the exploitation of natural resources and gains derived from the sale, exchange, or other disposition of such property or of the right giving rise to such royalties or other payments, may be taxed by the Contracting State in which such real property or natural resources are situated.

      • For purposes of this Convention, interest on indebtedness secured by real property or secured by a right giving rise to royalties or other payments in respect of the exploitation of natural resources shall not be regarded as income from real property.

      • (2) Paragraph (1) shall apply to income derived from the usufruct, direct use, letting, or use in any other form of real property.

What does this Mean?

Of importance is that this paragraph of United States-Republic of Korea Tax Treaty, which uses the words “may be taxed” and not shall be taxed or shall only be taxed. Therefore, with this paragraph it is essentially saying is that either contracting state has the opportunity to tax real property income.

Dividend, Interest & Royalties Under the United States-Republic of Korea Tax Treaty

When it comes to passive income such as dividend, interest and royalties the Korea/US tax treaty is similar to many other tax treaties on this specific issue, and each country gets the opportunity to tax the income  — but with limitations. For example, a US citizen who is earning dividend income from the United states but resides overseas can be taxed by both contracting states on the income.

But, there is a limitation on the amount of tax that can be imposed when the contract as in this example (United States) is taxing dividend income derived from sources within the United states by a resident of Korea.

These sections can get very complicated, but the most important takeaway is that there is a limitation to the amount of tax that can be issued and of course the double taxation rules will further limit any duplication in taxation.

Offshore Reporting (FBAR & FATCA) & United States-Republic of Korea Tax Treaty

When a US person has various Accounts, Assets or Investments in Korea, they have to reported to the United States each year on various different forms depending on the value of and category of the assets/accounts.

Here are some common forms which may need to be filed:

5 International Tax Forms You May Have Missed

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:.

      • Single or Filing Separate (in the U.S.): $50,000/$75,000

      • Married with a Joint Returns (In the U.S): $100,000/$150,000

      • Single or Filing Separate (Outside the U.S.): $200,000/$300,000

      • Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

      • Gift from a Foreign Person: More than $100,000.

      • Gift from a Foreign Business: More than $16,076.

      • Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

      • Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.

      • Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.

      • Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.

      • Category 4: Control of a foreign corporation for at least 30 days during the accounting period.

      • Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company).

The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Receiving a Gift or Inheritance From Korea

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in Korea Report U.S. Account Holders?

As of now, there are nearly 2000 Foreign Financial Institutions, within Korea that report US account holder information to the IRS. The list can be found here: Korea FFI List:.

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much more broad spectrum of assets and accounts, including:

      • Bank Accounts

      • Investment Accounts

      • Retirement Accounts

      • Direct Stock Ownership

      • ETF and Mutual Fund Accounts

      • Pension Accounts

      • Life Insurance or Life Assurance Policies

Totalization Agreement & the United States-Republic of Korea Tax Treaty

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the IRS:

      • “The United States has entered into agreements, called Totalization Agreements, with several nations for the purpose of avoiding double taxation of income with respect to social security taxes.

        These agreements must be taken into account when determining whether any alien is subject to the U.S. Social Security/Medicare tax, or whether any U.S. citizen or resident alien is subject to the social security taxes of a foreign country”

The United States has  entered into 26 Totalization Agreements, including Korea (as of 2002).

United States-Republic of Korea Tax Treaty is Complex

In conclusion, The US and Korea tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure on matters involving the United States-Republic of Korea Tax Treaty

Contact our firm for assistance.