Income tax treaties do not cover state income taxes. However, many states define income based on federal taxable income or federal adjusted gross income.
Some states allow students and scholars to exempt the same amount of income from state taxes and, in other states, they must add back in the treaty exclusion. Some of the states that do not allow treaty benefits are: Alabama, Arkansas, California, Connecticut, Hawaii, Kansas, Kentucky, Maryland, Mississippi, Montana, New Jersey, North Dakota, and Pennsylvania. Contact your state tax department to determine the allowance of tax treaty benefits when calculating state income tax.
The India treaty allows students to claim the standard deduction on their federal return. Since some states base the state income tax on the federal adjusted gross income, Indian students do not always benefit from their treaty provisions on the state returns.
Note: The forms may change after this material becomes available. Screen shots may depict a previous year's version of the forms or software. Publication 4491X, VITA/TCE Training Supplement, will be released in January to notify volunteers of any tax law and software updates.
The article touches on several intricate aspects of income tax treaties, state income taxes, federal taxable income, federal adjusted gross income, treaty benefits for students and scholars, and the relationship between federal and state tax regulations. Let's break down these concepts:
Income Tax Treaties:
Income tax treaties are bilateral agreements between countries designed to mitigate double taxation issues for individuals and entities earning income in both treaty-partner countries. These treaties specify which country has the primary right to tax specific types of income.
State Income Taxes:
States in the U.S. impose income taxes separate from federal taxes. However, the connection between federal and state taxes is crucial because some states use federal definitions or calculations as a basis for determining state taxable income.
Federal Taxable Income (FTI) and Federal Adjusted Gross Income (AGI):
FTI is the income subject to federal income tax after various deductions and exemptions. AGI is an individual's total gross income minus specific deductions allowed by the Internal Revenue Code. States often use these figures as a basis for their own tax calculations.
Treaty Benefits for Students and Scholars:
Many tax treaties have provisions that allow students and scholars from treaty countries certain exemptions or benefits regarding their income earned in the U.S. However, the application of these treaty benefits varies across states. Some states honor these benefits, while others might have different rules or restrictions.
States Handling Treaty Benefits:
The article mentions specific states that do not allow treaty benefits for income tax purposes: Alabama, Arkansas, California, Connecticut, Hawaii, Kansas, Kentucky, Maryland, Mississippi, Montana, New Jersey, North Dakota, and Pennsylvania. Individuals in these states may have to add back the treaty exclusion when calculating their state income tax.
Indian Students and Treaty Provisions:
Under the India treaty, students can claim the standard deduction on their federal return. However, since some states use federal AGI as a basis for state income tax, Indian students might not always benefit from these treaty provisions when filing their state tax returns.
Guidance and Updates:
It's important to note that tax laws and forms can change, so the mentioned information might become outdated. Publication 4491X, VITA/TCE Training Supplement, is scheduled for release in January to update volunteers on any law or software changes.
This comprehensive overview highlights the complexities involved in navigating income tax treaties, state tax regulations, and the interplay between federal and state tax systems, especially concerning treaty benefits for certain individuals like students and scholars.
