Israel and the United States have a tax treaty between them. It prevents Israeli-Americans from paying income tax twice on the same earnings. However, there is no similar treaty covering social security tax, better known as bituach leumi in Israel and FICA (Federal Insurance Contributions Act) payments in America. As a result, income tax, FICA tax, and bituach leumi tax could all be levied on the same income, which could result in a person having to pay over 70% of his or her income in taxes.
Israel has social security tax treaties with thirteen other countries. The US maintains similar treaties with twenty countries. With nearly 100,000 US citizens living in Israel, it seems high time for a social security tax treaty between the two countries. Such a treaty would mitigate unemployment and stimulate economic growth, while boosting aliyah.
The combined US and Israel social security tax obligation applies to many different people in different situations. The hardest hit are the self-employed. In fact, even if a self-employed US citizen resides in Israel, works exclusively in Israel for Israelis only, and receives all payment for services in Israel, that person is still liable to pay US FICA tax on all his or her income. This is despite the fact that none of the income was earned in the US or has any connection with the US.
The FICA/bituach leumi tax trap also applies to Israeli residents working in the US as employees of US companies. Such people are liable to pay their FICA contributions in addition to bituach leumi on the wages earned abroad.
With bituach leumi rates ranging from about 10% to about 15%, and FICA at 15.3%, a self-employed person may face an additional tax of about 30%. Since the top Israeli income tax rate is 45%, an individual could potentially pay out 75% of their income in taxes! Such staggering tax rates are extortionate. They are counterproductive for the following reasons:
First, Israeli-Americans might choose not to work at all as self-employed people or pursue job opportunities in the US. It is just is not worthwhile to go home with 25 agorot for every shekel earned. This deprives the Israeli economy of income that would have been earned in the US but spent in Israel.
Second, the Israeli-American will probably opt to pursue other employment in Israel, thus either taking away jobs from other Israelis, or draining the social welfare system of unemployment benefits. The harsh tax realities could turn even someone who earns a solid wage into a welfare case (unemployment and underemployment statistics range between 10% and 18% in Israel).
Third, the steep combined social security rates may discourage aliyah from the US. Many North Americans view aliyah as financially feasible only if they can hold onto their jobs abroad. If they see that their income will be seriously hurt, aliyah may no longer be an option. The most important right Israel can give new immigrants is the right to earn a living wage.
Finally, a social security tax treaty would benefit both the Israeli government and its citizens. A treaty would effectively cut tax rates and probably boost total income and social security tax revenue.
Time and again, it has been shown that total tax revenue rises when tax rates are slashed. When President Ronald Reagan implemented the Economic Recovery Tax Act in 1981, he gradually cut taxes across the board by 25%, as well as cutting the highest marginal tax rate from 70% to 28% over the course of his administration. Despite these cuts, federal income tax revenue steadily increased, particularly tax collection from the wealthy. Tax rate cuts provide greater incentives to work and produce, which helps the economy overall. Lower tax rates also encourage the taxpayer to report income honestly.
The 1975 income tax treaty was a step in the right direction, but it was only the first part of the process. It is in the best interests of the Israeli government, the Israeli economy, and Israeli citizens, for the government to negotiate a social security treaty with the US as soon as possible. Debbie Inker is a CPA who has lived in Israel since 2002. She advises companies in both Israel and the US.
Published by Globes [online], Israel business news - www.globes.co.il - on July 20, 2005