It is my understanding that in the 3rd year of being on an H1B visa one would need to file an 1040NR and NOT the 1040NREZ. Is this true?

Additionally are there any tax treaty between US & Pakistan that would give H1Bs some deduction?

Thanks!

If you are on the third your of an H-1B, you file as a resident alien, filing Form 1040, 1040A or 1040EZ.

On H1-B, not even a single day is exempt from residency.

Normally,
First year you are nonresident or dual status,
Second and Third Year you are resident.
Read about H1-B tax filing: Your U.S. Tax Return: The U.S. Visas (http://taxipay.blogspot.com/2008/08/us-visas.html)