US-Spain Tax Treaty: Pay in the US, Credit in Spain

The U.S.-Spain Income Tax Treaty is a vital document for American retirees living in Spain, as it determines which country has the right to tax various streams of retirement income and provides mechanisms to prevent double taxation. Navigating its provisions is essential for compliance and financial planning.

The cornerstone of this financial landscape is the Convention for the Avoidance of Double Taxation between the United States and Spain. This bilateral agreement is critical for preventing income from being taxed by both countries, and its specific provisions are particularly consequential for those living on retirement savings and Social Security.

The treaty’s primary importance lies in its ability to provide clarity, predictability, and significant tax savings, allowing retirees to budget effectively without the fear of an excessive tax burden. For a U.S. retiree in Spain, several key points of the treaty rise to the forefront.

The Saving Clause: The Primacy of U.S. Citizenship-Based Taxation

The most critical concept for American retirees to understand is the “saving clause.” This standard provision in U.S. tax treaties reserves the right for the United States to tax its citizens as if the treaty did not exist. This means that regardless of your residency in Spain, you remain fully obligated to file a U.S. tax return and report your worldwide income.

The U.S. will still tax you on your income according to its own rules.

The treaty’s main role being to prevent Spanish tax from layering on top.

This underscores a fundamental point: moving to Spain does not absolve one of U.S. tax filing obligations. The treaty is a shield against double taxation, not a waiver of U.S. filing requirements.

Spanish Tax Residency and Reporting: Tie-Breaker Rule (Article 4)

For retirees, becoming a Spanish tax resident is triggered by spending more than 183 days in Spain during a calendar year. As a resident, you must declare your worldwide income on the Spanish IRPF form. Retirees must also be aware of Spanish filing obligations beyond income tax:

Modelo 720: Mandatory disclosure of foreign-held assets (bank accounts, investments, real estate) exceeding $50,000.
Wealth Tax: Spain’s national and regional wealth taxes may apply depending on your net worth

Determining your country of residence is the first step in applying the treaty. If you are considered a resident of both the U.S. and Spain under their respective domestic laws, the treaty provides a “tie-breaker” test. This test looks at factors like your permanent home, center of vital interests (your closer personal and economic ties), and habitual abode.

For most retirees who have moved their lives to Spain, they will be deemed a Spanish resident for treaty purposes. This is significant because it determines which country gets the primary right to tax certain types of income. It’s essential for claiming treaty benefits.

Taxation of Pensions (Article 18)

This is often the most relevant article for retirees. The treaty states that private pensions and annuities are taxable only in the recipient’s country of residence. Therefore, for a U.S. retiree living in Spain, distributions from a 401(k), IRA, or private annuity are taxable only in Spain. The U.S. surrenders its right to tax this income.

For private pensions, which include distributions from accounts like 401(k)s, IRAs, and other private employer-sponsored plans, the primary taxing right is generally given to the country of residence, which is Spain.

Taxation in Spain: As a Spanish tax resident, your private pension distributions are treated as ordinary income. It’s axed at Spain’s progressive income tax rates, which can range up to 47%. Furthermore, Spain typically does not recognize the tax-deferred or tax-free status of U.S. retirement accounts (like Roth IRAs or the tax-deferred portion of traditional 401(k)s/IRAs) upon distribution. This means the full amount is usually taxable in Spain.
Double Taxation Relief: Since the U.S. reserves the right to tax its citizens on worldwide income via the Saving Clause, your pension income is generally taxable in both countries. To avoid double taxation, the treaty enables you to claim a Foreign Tax Credit (FTC) on your U.S. return for the income tax paid to Spain. Given Spain’s generally higher income tax rates, the FTC often eliminates or significantly reduces any U.S. tax liability on this income.

Taxation of Social Security Benefits (Article 18)

However, the treatment of U.S. Social Security benefits is different. The treaty grants the right to tax Social Security exclusively to the country making the payment—in this case, the United States. This is a crucial advantage. Spain cannot tax your U.S. Social Security payments. Furthermore, because up to 85% of Social Security benefits can be tax-free on your U.S. return (depending on your total income), many retirees find their Social Security is entirely or largely free from tax in both countries.

The most favorable provision for many retirees concerns U.S. Social Security. Under Article 20 of the treaty, the taxing right for U.S. Social Security benefits is generally reserved exclusively to the United States.

Taxation in the U.S.: You will still file a U.S. tax return ($1040) and report your Social Security income, which may be partially taxable under U.S. domestic law.
Exemption in Spain (with Progression): Spain cannot directly tax the benefit. However, a crucial Spanish tax concept called “Exemption with Progression” applies. You are mandated to declare the Social Security income on your Spanish Personal Income Tax (IRPF) return. While the income itself is exempt, its inclusion is used to calculate the higher progressive tax rate that will be applied to your other taxable income (like private pensions or investment income).

Elimination of Double Taxation: The Foreign Tax Credit (Article 23)

This is the engine that makes the treaty work. Both countries agree to provide relief from double taxation. For U.S. citizens, the primary mechanism is the Foreign Tax Credit (FTC). If you have income that is taxable in both countries, the U.S. will allow you to claim a dollar-for-dollar credit on your U.S. tax return for the income taxes you paid on that same income to Spain. This prevents you from being taxed twice on the same dollar.

For instance, rental income from a U.S. property, which the treaty allows both countries to tax.

AEAT

Spain: Agencia Estatal de Administración Tributaria

Tax Treaty in AEAT

IRS

USA: Internal Revenue Service

Tax Treaty in IRS

Key Considerations Beyond the Treaty

Wealth Tax: The treaty does not shield U.S. retirees from Spain’s Impuesto sobre el Patrimonio (Wealth Tax). This annual tax on worldwide net assets above a high exemption threshold can be a significant liability. Therefore, it requires careful planning.
Form 8938 & FBAR: U.S. citizens must still comply with foreign asset reporting requirements like FinCEN Form 114 (FBAR) and Form 8938, which are separate from income tax and carry steep penalties for non-compliance.
Spanish Residency: Once you spend more than 183 days in Spain in a calendar year, you become a Spanish tax resident and are subject to tax on your worldwide income.

In conclusion, the U.S.-Spain tax treaty is an indispensable tool for American retirees. It provides a structured framework that can prevent a financial nightmare and make a Spanish retirement financially viable. The treaty secures favorable treatment for pensions and Social Security and provides mechanisms like the Foreign Tax Credit.

This way, the treaty allows retirees to enjoy the Spanish way of life with greater fiscal confidence and predictability.