(Federal tax treaties can cut a newcomer’s federal income tax bill to zero on certain wages, scholarships, pensions, dividends, or interest. But many immigrants and globally mobile workers learn too late that the promise of treaty relief often stops at the state line. The core problem is simple: U.S. states are not bound by federal tax treaties, so state taxes can turn a federal exemption into a surprise bill and, in some cases, real double taxation.)
Federal tax treaties: what they cover, and what they don’t
The United States 🇺🇸 has a wide network of bilateral income tax agreements meant to prevent the same income from being taxed twice and to make cross-border work, study, and investment easier.
Common treaty tools include:
– rules that decide who is a tax resident,
– reduced or zero federal tax on certain kinds of income, and
– specific carve-outs for students, trainees, and short-term workers.
Under the Constitution’s Supremacy Clause, treaties are federal law and can override conflicting federal statutes. In practice, the IRS generally honors properly claimed treaty benefits for federal taxes.
What treaties usually do not do is preempt state law. Unless a state has copied treaty language into its own tax code, a treaty article that shelters income at the federal level may have no effect on a state return.
Why states can ignore treaty benefits
States are separate taxing authorities with their own:
– income tax rules,
– definitions of taxable income, and
– withholding expectations.
Many states begin with “federal taxable income” and then make state-specific adjustments. That starting point can mislead filers into thinking a federal treaty exclusion automatically applies at the state level.
Courts have generally accepted that states may tax unless Congress has clearly barred them from doing so. The U.S. Supreme Court has required explicit treaty language before a treaty will block state taxation—language that most income tax treaties lack.
Federal and state systems also test tax power differently:
– Federally, the question often considers whether income is effectively connected to a U.S. trade or business or whether a taxpayer has a permanent establishment under a treaty.
– At the state level, many agencies look at nexus—enough contacts with the state to justify taxation.
Because nexus thresholds can be lower than the treaty’s permanent-establishment standard, someone can be outside federal tax under a treaty yet still fall inside a state’s tax net.
Where the mismatch shows up most often
The source flags several states for non-recognition or limits on treaty benefits. States frequently cited include Alabama, Arkansas, California, Connecticut, Hawaii, Kansas, and Kentucky.
High-impact states often mentioned by immigrants and employers are California, New York, New Jersey, and Pennsylvania. Policies vary by state; a small number partly conform, but full recognition remains rare.
California merits special attention:
– It can treat people as tax residents even when they live abroad.
– It does not apply federal tax treaty benefits at the state level.
For a worker who moved to the U.S. for a job and later relocated overseas, a mix of California’s residency rules and non-recognition of treaties can produce years of tax stress if domicile and residency facts are not clean.
Students and trainees: treaty relief federally, taxable income locally
International students on F-1 and J-1 visas are among the most exposed groups because many treaties contain generous student provisions.
Treaty exemptions commonly apply to:
– scholarships and fellowships,
– on-campus employment income, and
– practical training earnings.
At the federal level, these exemptions can reduce or eliminate income tax. But in states such as California and New York, that same income may be taxed in full.
Consequences:
– Students can face cash-flow problems when state tax bills appear at filing time.
– Universities can inadvertently under-withhold on state obligations if payroll staff assume treaty rules carry over, creating compliance exposure for both students and institutions.
H-1B and other employment-based visas: “day one” state tax
For H-1B workers and others on employment-based visas, treaties sometimes offer partial wage exemptions, short-term relief, or reduced rates.
States, however, may:
– tax full wages from the first day in the state,
– ignore treaty tie-breaker residency rules, and
– raise total tax even when the federal return shows treaty protection.
This gap is particularly harmful in high-tax states and can be thousands of dollars. It also affects employer budgeting: firms that estimate after-tax pay using federal treaty benefits may find employees upset when state taxes erase expected savings.
Green card holders and new immigrants: foreign income and pensions
A green card can quickly change a person’s tax status because federal law may treat permanent residents as U.S. tax residents.
Treaties may still provide relief for certain items, such as foreign pensions, and aim to limit double taxation on overseas income. But many states do the opposite:
– some tax foreign pensions already taxed abroad,
– some disallow foreign tax credits, or
– some ignore treaty-based exclusions.
The result can be actual double taxation: the home country taxes a pension or investment return, the federal government may offer treaty help, yet the state taxes again with no matching credit.
Digital nomads and remote workers: treaty logic meets state residency rules
Remote work increases the likelihood of mixed residency facts. A digital nomad or remote employee may qualify for treaty benefits federally but still be claimed as a state resident based on physical presence or domicile.
This creates international ripple effects:
– If a home country gives credit only for federal U.S. income tax paid, a person who pays mostly state tax may not receive full foreign relief.
– The taxpayer ends up paying state tax with no credit abroad, increasing the risk of double taxation.
Business filings and the 2017 state survey
Employers face separate traps. Some states require companies to compute state taxable income “as if” they had taxable income under federal law—even when a federal tax treaty would remove that income from the federal base.
A 2017 survey of state tax departments (cited in the source) reported that responses from 15 states indicated they do not permit the federal tax treaty exemption for state tax purposes.
Consequences for multinational employers:
– extra filing duties,
– additional tax liabilities, and
– potential penalties if the company assumes the federal treaty result carries over.
What claiming a treaty looks like at the federal level
Mechanics matter. Many treaty positions must be disclosed on the federal return.
Key federal steps:
1. Determine the treaty article and the type of income involved.
2. Report the treaty-based position on the federal return.
3. Attach Form 8833, “Treaty-Based Return Position Disclosure,” when required.
The source specifically notes Form 8833. Taxpayers who claim a treaty-based return position may need to attach Form 8833, citing the treaty article and the income type. The official IRS form page is here: IRS Form 8833.
This form helps the IRS understand why an amount was excluded or a special rule applied. It does not, by itself, protect a person from state taxation. A separate, state-specific analysis is generally required.
For general federal treaty guidance, the IRS maintains a treaty resource page at IRS: United States Income Tax Treaties.
Practical planning points for immigrants, students, and employers
Based on the source material, assume treaty benefits stop at the federal return unless you confirm state conformity.
Practical tips:
– State residency rules can differ from federal rules. You may be a nonresident federally but a resident for state purposes.
– Location choices matter. Living in a state with lower or no wage income tax can significantly reduce the gap between federal treaty relief and total tax.
– Check payroll and stipend withholding for state rules. Employers, colleges, and universities should not assume treaty-exempt wages or stipends are exempt for state withholding.
– Obtain specialized advice. Cross-border tax work requires professionals who can read treaty articles and apply state residency and sourcing rules.
Important takeaway: Treaty relief that reduces federal taxes often does not prevent state taxation. Confirm state conformity before relying on treaty benefits for budgeting, withholding, or filing decisions.
According to analysis by VisaVerge.com, this mismatch is a recurring pain point for foreign nationals who plan around federal treaty benefits but then file their first state return and find unexpected tax due.
Federal tax treaties offer significant relief for foreign nationals, but this protection often stops at the state line. Because U.S. states are separate taxing authorities, they are not bound by federal agreements unless they specifically adopt them. This lack of conformity frequently results in surprise state tax bills for students, workers, and retirees who assume their federal exemptions apply universally, potentially leading to double taxation.
