It is the start of a new year once again, which means that the tax season has just started. This is a particularly painful topic when it comes to nonresident aliens. Temporary visitors of the U.S. who are employed in the U.S or receive any other type of income might owe the IRS hundreds and thousands of dollars in taxes. It is often the case these individuals are not even aware of tax implications and the need to pay taxes. If liability does not get settled on time, fees and penalties start adding up… Those who do have some tax compliance background might not be in a better position either – what are the timelines? what forms to use? how to file?
Unfortunately, this matter is not widely discussed, as of course, only tax professionals can give an actual legal advice when it comes to taxes. But what are the main things to be aware of when dealing with non-U.S. citizens? Especially, if you are the one making payments to/on behalf of these individuals? Some non-profits directly employ non-U.S. residents; others support their academic pursuits through grants and scholarships. Study grants can be especially tricky – the non-profit might be just a pass-through entity. So, what if the funder imposed a requirement to ensure students’ tax compliance on the prime recipient? Not only would it be nice for you to understand all the nuts and bolts of nonresident tax compliance, but you actually now have a contractual obligation to ensure that you’re in compliance with state and federal tax requirements; and you also need to make all the necessary withholdings and prepayments. No wonder this topic is very popular in the non-profit world. Unfortunately, there is no cookie cutter approach and every single case needs to be handled differently. Based on my experience, I recommend following these initial steps:
- It is safe to say that regardless of the situation you should start with confirming the tax status of the individual in question. This has nothing to do with the immigration status, by the way. The difference between resident alien and nonresident alien is key, as this will determine what tax laws will be applicable to the individual. A person would be considered an alien if he/she doesn’t pass one of the two tests: green card test or substantial presence test. In simple words – if the person has a green card OR has been in the US long enough (there is an actual formula for that) – he or she will be considered resident alien for tax purposes. This means that the individual will be generally taxed in the same way as any other U.S. citizen. If the person doesn’t have a green card and hasn’t been in the U.S. long enough to meet the substantial presence test – he or she will be considered nonresident alien and will be taxed on U.S. source of income.
- Once the tax status is confirmed, identify the nationality of the individual. Double-check whether there is a tax treaty in place between the U.S. and the country of origin. If a tax treaty applies to a given individual this can help to reduce (or even eliminate) U.S. tax. Make sure to check the IRS website regularly, as more countries can be added to the list.
- Do the math. Once the tax status has been established and the tax treaty provisions verified, every payment made to/on behalf of the nonresident alien needs to be scrutinized and a tax should be withheld, if applicable. Depending on the type of income (taxable part of U.S. scholarship or grant, investment income, wages, etc.) different tax rates would apply to the abovementioned income. A neat table summarizing all the possible scenarios is offered by the IRS here.
These initial steps in determining tax compliance are the easiest, to the degree that they could be partially or fully automated. It’s the exceptions and special provisions that come next, that can cause real confusion and frustration. Taxation of foreign students and scholars is a good example of a microcosm within complex topic of nonresident alien taxation.
Stay tuned for upcoming conversation on foreign students/scholar and various types of study grants!