April 10, 2014

This article was written by Solomon Packer CPA, JD, LLM in Taxation, and printed here with his permission.

Unlike most U.S. income tax treaties, the tax treaty with Israel included a provision which on its face implies that U.S. Social Security recipients living in Israel will not have to pay U.S. or Israeli income tax on their Social Security receipts.

Article 21 of the U.S. Israeli tax treaty provides, “Social Security payments made by one country to residents of the other are to be exempt from tax in both countries”. Unlike other U.S. tax treaties, the treaty with Israel further provides that this specific provision is applicable to U.S. citizens. Other provisions of the U.S. Israeli tax treaty, under what is called the “Savings Clause” do not apply to U.S. citizens, as the U.S. under the treaty retains the right to tax its citizens as if the treaty does not exist.

Based on the above comments, can it be said that U.S. citizens who reside in Israel can receive U.S. social security payments free of tax? The answer to this question is dependent on whether the U.S. citizen’s income from outside Israel is subject to Israeli income tax.

Article 21 of the treaty requires the U.S. citizen receiving the social security payments be a “resident” of Israel. Article 3 of the treaty includes a definition of the term “resident of Israel” for purposes of Israeli tax. As used in the treaty, a resident of Israel includes persons on whom taxes are imposed by Israel, under the Income Tax Ordinance, on income from sources outside of Israel by virtue of their being Israeli citizens.

As concerns U.S. citizens who have lived in Israel for more than 10 years, they, like all Israeli citizens, are subject to Israeli income tax on their worldwide income. Social Security payments received by these persons can be received free of both U.S. and Israeli income tax.

It is questionable, however, whether this exemption from tax, would apply to a new oleh. A new oleh, under Israeli law, receives a 10 year exemption on capital gains earned on overseas assets. New olehs also receive a 10 year exemption on overseas income not earned in Israel. It therefore is questioned whether a new oleh during the 10 year exemption period is considered a “resident of Israel” for purposes on the U.S.-Israel income tax treaty based upon the US Treasury Explanation of Article II of the Protocol. If the new oleh is not considered a “resident of Israel” for purpose of the treaty, 85% of U.S. social security payments received by a new oleh who is a U.S. citizen would be subject to U.S. income tax.

The Israel-U.S. income tax treaty was negotiated in years in which certain Israeli residents were taxed by Israel on the remittance basis. That is, non Israeli income was taxed by Israel only if the income was repatriated to Israel. The tax treaty therefore sought to differentiate Israelis taxed on the remittance basis from Israelis who were taxed on their worldwide income. The exemptions applicable to new olehs were not the reasons for the special residence definition of the treaty, and the application of the residence definition to the new oleh is merely a coincidence.

Therefore, the current situation as applicable to new olehs was not anticipated when the treaty was negotiated and should not presently cause social security payments received by a new oleh to be subject to U.S. income taxation. Nevertheless, at present this issue is unresolved and should be considered by the treaty negotiators.