The Tax Times: U.S. Citizen's Capital Gains Taxable Under U.S.-Israel Treaty According to US Tax Court

Tuesday, May 24, 2016

U.S. Citizen's Capital Gains Taxable Under U.S.-Israel Treaty According to US Tax Court

The Tax Court has concluded that a "pro se" taxpayer who was a U.S. citizen and permanent Israel resident was taxable on his capital gains.

Although the taxpayer argued that such gain was excluded from U.S. tax under one provision of the U.S.-Israel income tax treaty, it was nonetheless taxable under the treaty's “saving clause.” Cole, TC Summary Opinion 2016-22.

Article 15, paragraph 1, of the Convention between the Government of the United States of America and the Government of Israel with Respect to Taxes on Income, U.S.-Israel, Nov. 20, 1975 provides that “[a] resident of one of the Contracting States shall be exempt from tax by the other Contracting State on gains from the sale, exchange, or other disposition of capital assets.”

The U.S.-Israel income tax treaty includes a “saving clause” Article 6, paragraph 3, of the treaty provides that “[n]otwithstanding any provisions of this Convention except paragraph (4), a Contracting State may tax its residents and its citizens as if this Convention had not come into effect.”

After moving to Israel in 2009, Elazar Cole, a U.S. citizen, became a permanent resident of Israel in 2010. As a result of moving to Israel, he qualified for a 10-year Israeli “tax holiday,” which exempted him from Israeli tax on non-Israeli-source capital gain income.

Mr. Cole purchased 3,000 shares of stock in Neogen Corporation (Neogen), a Michigan incorporated entity. In 2010, he sold this stock and realized $114,947 of long-term capital gain.

On his 2010 Form 1040, U.S. Individual Income Tax Return, Mr. Cole reported the $157,012 of proceeds from the sale of Neogen stock on Schedule D, Capital Gains and Losses. However, he did not include any of the proceeds in his taxable income. On audit, IRS determined a $13,212 deficiency and a $2,642 accuracy-related penalty under Code Sec. 6662(a).

The Tax Court held that Mr. Cole had to recognize the $114,947 long-term capital gain of attributable to his sale of Neogen stock. He wasn't entitled to exclude the proceeds from his sale of this stock from U.S. taxation under Article 15, paragraph 1, of the U.S.–Israel income tax treaty. The Court found that the proceeds were subject to U.S. federal income tax under the U.S.-Israel income tax treaty's saving clause.

The Court stated that the saving clause did not nullify the treaty; it only nullified the benefits provided by certain provisions to current citizens and certain former residents and citizens. The U.S.–Israel income tax treaty provided that certain of its Articles took precedence over the saving clause—but Article 15 wasn't among them.

In addition, the saving clause applied only to current citizens and certain former residents and citizens of a Contracting State who currently resided in the Other Contracting State.

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