U.S. Tax Impact of U.S.-Hungary Income Tax Treaty Termination on Cross-Border Employees

On July 8, 2022, the U.S. provided diplomatic notification to the government of the Republic of Hungary of its termination of the U.S.-Hungary income tax treaty, which had been in force since 1979. The U.S. Treasury Department stated that the treaty’s benefits were no longer mutual and cited low economic benefits for the U.S. as the reason for the termination. For prior coverage, see U.S. Treasury Makes Rare Move to Terminate Tax Treaty With Hungary Amid Minimum Tax Debate.

The termination of the U.S.-Hungary income tax treaty was effective on January 8, 2023. However, in accordance with Article 26 (Termination) of the convention, the treaty will cease to have effect with respect to tax withheld at source on amounts paid or credited on or after January 1, 2024. For other taxes, the treaty ceases to have effect with respect to taxable periods beginning on or after January 1, 2024.

The notable provisions to globally mobile employees are highlighted below.   

Employment Income

Under Article 14 (Dependent Personal Services) of the terminated convention, income earned for services performed in the U.S. by a U.S. nonresident individual who was a resident of Hungary —which would generally be taxable income under U.S. domestic law — could be exempt from U.S. tax under certain conditions. Generally, income received by an individual (1) who was present in the U.S. for less than 183 days in the taxable year, (2) whose income was paid by a non-U.S. employer, and (3) whose compensation was not borne by a U.S. permanent establishment of the foreign employer, could be exempt from U.S. income tax. In the absence of the treaty, this same income will now generally be subject to U.S. income tax, even if the same conditions continue to be satisfied.

Residency

An individual who was a resident of both the U.S. and Hungary under each country’s domestic laws previously could rely on Article 4 (Fiscal Domicile) of the terminated convention to assign a single country of tax residency under the tie-breaker rules. Now that the treaty is not in force, this same individual will be subject to tax in both countries on their worldwide income.

Taxes Covered

Article 2 (Taxes Covered) of the terminated convention designated specific Hungarian and U.S. taxes to which the income tax treaty applied and which Hungarian taxes would be creditable in the U.S. The 2022 foreign tax credit final regulations included a treaty coordination rule that allowed foreign taxes treated as income taxes under a U.S. income tax treaty to continue to be creditable for purposes of the foreign tax credit. However, in the absence of a U.S. income tax treaty, a U.S. individual must determine under the new foreign tax credit regulations — which now require that certain attribution rules be met — if a foreign levy is a creditable foreign income tax under the Internal Revenue Code. For the 2023 tax year, the IRS provided temporary relief when determining the creditability of a foreign tax and allows taxpayers to determine creditability under the former foreign tax credit rules. For prior coverage, see Notice 2023-55 Offers Temporary Relief from Final FTC Rules.

Tax Withholding on Some U.S.-Source Income

With the termination of the income tax treaty, the reduced withholding rates on some items of income that individuals previously enjoyed will no longer be available. For example, under Article 9 (Dividends) of the terminated convention, dividends paid to a resident of the other country were generally subject to a withholding rate of 15%. In the absence of the treaty, U.S.-source dividends received by a resident of Hungary who is not a resident of the U.S. will generally be subject to U.S. federal income tax withholding at a rate of 30%.

Similarly, under Article 10 (Interest) of the terminated convention, U.S.-source interest income was exempt from tax at source. Now, with the treaty no longer in effect, this same income will generally be subject to U.S. federal income tax withholding at a 30% rate.

Next Steps

With the upcoming 2023 tax filing season, employers with cross-border employees who previously relied on the U.S.-Hungary income tax treaty to exempt employment income from U.S. taxation should review their global mobility population and speak with their tax advisor to determine what changes to tax services may be needed for the 2023 tax year. The same is true for employers with employees who were previously treated as U.S. nonresidents under the treaty tie-breaker rules.

In addition, in preparation for the 2023 tax compliance season (and especially the 2024 tax year), employers with U.S. individuals in their international assignment programs who are subject to Hungarian income tax should speak with their tax advisor to determine if the tax is creditable for purposes of the foreign tax credit.

When an individual who is a resident of Hungary and a nonresident of the U.S. receives passive income — such as interest and dividends — withholding forms that were previously provided to withholding agents should be reviewed and revised. For example, because the termination of the U.S.-Hungary income tax treaty is considered a change in circumstances, individuals who previously indicated their eligibility for the reduced treaty withholding rate on Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals)) must notify the withholding agent of the change and submit a new Form W-8BEN for the 2024 calendar year.