I. Domestic Administration of Social Security Taxation and the Scope of International Coordination – continued

c. The Third Aspect: Taxation of Benefits

Up to 85% of social security benefits received by United States citizens and residents are included in income and subject to taxation, depending on the level of benefits, tax filing status, and other income received. For non-United States citizens and non-residents, income tax is generally withheld by the payor of benefits at a rate of 30% of 85% of the gross benefit amount, or an effective rate of 25.5%.

This jurisdictional overlap is typically dealt with by tax treaties. If not for tax treaties, benefits would be taxed twice. For example, a person who lives abroad and receives United States social security benefits would be subject to withholding in the United States as the country of source. At the same time, those benefits would be classified as income in the taxpayer’s home country because that is where she resides. Similarly, a person in the United States that receives social security benefits from a foreign country could be taxed on those benefits in the United States while simultaneously being subject to source-based taxation by the foreign country paying the benefits.

Unlike the problems of double social security contributions, which are addressed in all SSTAs and some treaties, double taxation of social security benefits is addressed in treaties. The U.S. Model Tax Treaty employs a source-based approach to the taxation of social security benefits, preserving the paying country’s right to tax the benefits it pays out.

Despite this standard, many tax treaties prohibit source-based taxation in favor of residence-based taxation. This is the case for tax treaties with Canada, Egypt, Germany, Ireland, Italy, Japan, Morocco, Pakistan, Switzerland, and the United Kingdom. Complete exemption of social security benefits is provided by both countries in the tax treaties with Israel and Romania. Under these treaties, residents of these countries are not subject to United States taxation on United States benefits they receive.