Do you owe tax on income earned in ISRAEL?

Filing yearly tax returns does not necessarily mean you have a tax liability in the U.S. You must differentiate between your Tax return filing obligation and the Tax outcome of filing the return.

Your worldwide income can be divided into two main types: active income and passive income. It is necessary to distinguish between these two types of income when trying to determine if a tax liability may result as a result of reporting that income on your federal return.

Please note that American citizens are obliged to report their worldwide income as part of their yearly tax filling obligation .This means American citizens must report their income derived from Israel to the American tax authorities.

Active income – unlikely to result in a tax liability

There are two main reasons why it is unlikely that Wages or self employed income earned in ISRAEL will result in  a tax liability when filing a U.S return:

1. Israel – U.S tax treaty  that is intended to protect citizens from double taxation. American citizens are susceptible to a tax liability in the U.S only If the tax bracket in the US is higher than the tax bracket in Israel. If that is the case American citizens must pay tax differentials. As the tax brackets in Israel are generally higher than the tax brackets in the USA, this is unlikely.
2. The IRS allows every American citizen to exclude foreign active income earned outside of the U.S under certain conditions by filing form 2555, foreign earned income exclusions

For example, the maximum amount that you could exclude in 2015 under the status Single, was $100,800 and $201,600 under the status married filing jointly.

Passive income – may result in a tax liability

Passive income comprises of different types of income and the tax treaty relates differently to each of them.

It is possible to generalize and simplify the conditions in which you are susceptible to a tax liability on passive income earned in ISRAEL. The basic Principle is that American citizens are susceptible to a tax liability in the U.S only If the tax bracket in Israel is lower than the tax bracket in the US.

Whereas in Israel most passive income is taxed in a fixed tax bracket, regardless of the general level of income, in the US the tax rate on passive income depends on the adjusted gross income (AGI) , as reported on the individuals tax return.

Examples of different types of income in which the tax brackets in the U.S may be higher in comparison to the tax brackets in Israel:

• Rental income.
• Capital gains.
• Estate and gift tax.
• Income from Israeli’s mutual funds.
• options from work.

Please note the following tax aspects:

• As the general income grows the odds of having a tax liability in the US, on passive income made in Israel, grows accordingly.
• Implementing the right tax strategy will generally help you minimize any possible tax liability that may result from your passive income.
• Starting 2013 tax year the IRS has implemented the NIIT (Net investment income tax) on passive income  in a rate of 3.8%.

For a full comparison of U.S. and Israel Tax regulations based on income types please click HERE.