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Guide To U.S. Taxes for Foreign Nationals-
by Andrew C. Powers last updated 11/2010
Overview
Accepting an international assignment presents unique challenges to an expatriate employee as well as to the employer, one of the most critical being the employees’ local income tax responsibility. For both the employer and the employee, maintaining adequate compliance with the tax laws of the host country are of paramount importance, while at the same time minimizing the employees´ taxation tax burden.
The United States has one of the most complex tax systems when viewed in comparison to most countries, and the manner in which the foreign national expatriate is taxed in the U.S. (as regards both income and employment taxes such as social security) is in many respects determined by the tax status of the individual (whether the individual is considered as a tax resident or non-resident) and the application of U.S. tax laws, regulations and laws as regards each status as well as the provisions of the U.S. international income tax conventions and social security agreements (often referred to as Totalization Agreements).
Our objective is to facilitate the understanding of U.S. taxation of foreign national international assignees as regards their U.S. tax compliance requirements as well as estimate their net disposable income while on U.S. assignment.
As the information contained in this presentation is compiled in October 2010, it is based on the laws, tax rates and regulations in effect at this time. As considerable uncertainty and disagreement exists within the ranks of existing lawmakers, it cannot be determined at this time what changes, if any, will be made to U.S. tax laws that pertain to years 2010 and 2011. In the event of tax legislation that affects the contents of this publication, updates will be provided accordingly.
IRS CIRCULAR 230 NOTICE: To ensure compliance with recently enacted U.S. Treasury Department regulations, we hereby advise you that any and all tax information contained in this publication should not be considered as tax advice nor intended for the use of any taxpayer for the purpose of evading or avoiding tax penalties that may be imposed pursuant to U.S. law. Furthermore, the use of any tax information contained in this communication has neither been written nor intended for the purpose of promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any taxpayer, and such taxpayer should seek advice on the taxpayer’s particular circumstances from an independent tax advisor.
U.S. Taxes
that Apply to Foreign Nationals
Resident versus Non Resident Status
U.S. Income Taxation of Non Resident Aliens (NRA)
U.S. Income Tax Considerations for NRAs on Temporary Assignment in the U.S.
U.S. Income Taxation of Resident Aliens
Sources of Income Subject to U.S. Income Tax
U.S. Tax Considerations for Years Entering or Leaving the U.S.
Immigration Visas
U.S. Individual Income Tax Rates
Forms Used By Foreign Nationals
U.S. Tax Treaties
U.S. Tax Withholding
Non Tax Considerations
U.S. Taxes that Apply to Foreign Nationals
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U.S. Federal Income tax versus state income taxes: Although each of the 50 U.S. states have their own revenue laws, many are predicated on U.S. tax laws which are found in the United States Code, Title 26, The Internal Revenue Code of 1986 (Code) which imposes income, estate, gift, employment and excise taxes. The United States Congress will change U.S. tax laws as deemed appropriate through the legislative process thus enacting Revenue Acts to amend the Code. U.S. tax laws are the result of the legislative process of passing a bill through both houses of Congress which may be signed into law or vetoed by the President. Tax laws are then sent to the U.S. Department of the Treasury who is responsible for interpreting the law and promulgating regulations based on their interpretation. Within the Department of the Treasury exists the Internal Revenue Service which is responsible for administering the tax laws, collecting taxes and issuing rulings as regards procedure and application. Tax law can be further modified or clarified by the U.S. judicial system or courts, which is known as Case Law. Each state follows a similar legislative and administrative process, and each state is different. Accordingly, herein we shall devote our attention to strictly federal tax laws.
Every non U.S. person who received income from U.S. sources, including investment income, property ownership, salaries or income from self employment, needs to be aware of U.S. income tax laws that apply as regards tax filings and what taxes must be paid, how and when.
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Income Tax Treaties: The provisions of the U.S. Tax Code (as well as Case Law) maybe modified as a result of multinational income tax conventions (treaties) entered into between the U.S. and other countries. These treaty provisions affect the definition of who is a resident, what income may be exempt or required to be reported, which country (either the person’s home country or the host country) is entitled to tax the income and at what rates the income is taxed. The basic purpose of income tax treaties is to prevent double taxation of income.
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Social Security Taxes and Totalization Agreements: Because confusion existed for many years as far as to which country was entitled to collect contributions from multinational employers of international assignees, and which benefits the employees were entitled to collect and from whom, and to prevent double taxation of employment income and ensure benefits, the United States and several countries entered into Social Security (also known as Tax Totalization) treaties. As a result of these treaties employees on international assignment can often choose which country they wish to contribute to as far as social security or social pension and can also decide from which country to collect retirement benefits.
o The United States Social Security system is the result of the Social Security Act of 1935 which was later modified and codified as part of the U.S. Code, Title 26 as the Federal Insurance Contribution Act (FICA).
o It is a regressive tax in that there are no deductions and the tax is imposed on both employers and employees. Presently the contribution is segregated into two parts, Social Security Tax for which employers and employees each pay 6.2% of employee gross wages earned up to a maximum amount (wage base) as adjusted for inflation each year. For 2009 and 2010 the maximum earnings on which the contribution is based is $106,800. Additionally all wages are subject to an additional contribution of 1.45% (by each the employer and employee) for Medicare Benefits (federal medical care). The wage base for Medicare is unlimited.
o Both resident and non resident employees deriving U.S. wages (from U.S. employers) are subject to FICA taxes. There are exceptions however, including wages paid to NRAs who enter the country on certain visas, including (F-1, J-1, M-1 and Q-1 in addition to those who qualify for exemption pursuant to one of the totalization agreements.
Resident versus Non Resident Status
Determining whether one is a resident or non resident alien is of paramount importance in determining which tax forms to file, at what rates different types of income will be taxed, the filing status and what expenses and exemption deductions can be claimed.
In general a foreign national is considered to be a non resident of the U.S. for income tax purposes unless they are either:
1. Legal resident aliens, or “Green Card Holders” under U.S. immigration laws, or
2. A resident alien for U.S. income tax purposes under the “substantial presence test”.
Legal resident aliens: Persons with permanent lawful immigration residency status remain residents for U.S. tax purposes unless they either a) officially surrender their green card, b) the green card is revoked by the immigration authorities or 3) there is a judicial determination that the person has abandoned lawful resident status under the U.S. immigration laws.
Substantial Presence Test: The tax status of a foreign national will change (regardless of their legal immigration status) if:
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They are physically present for 183 days or more during calendar year or,
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They are present for at least 31 days in a calendar year and have been present in the U.S. for 183 or more “equivalent days” in the current and immediate two prior years. An equivalent day is determined as a full day in the current year, plus 1/3 of the number of days spent in the U.S. during the immediate prior year and 1/6 of the actual days spent in the third immediate prior year.
In general any time spent within a 24 hour period is considered as a full day for purposes of counting days with the exception of certain circumstances. Time spent in the U.S. while travelling between two international locations outside the U.S. will not be counted, nor will time spent if the individual is unable to leave due to serious medical conditions. Also commuters between Canada and the U.S. are not considered as being present in the U.S. for purposes of the substantial presence test. Certain other categories of persons are exempt from these requirements including a) foreign diplomats or employees of a foreign country (G-4 Visa holders) or immediate families of such persons; b) teachers or trainees and their immediate families with J or Q visas under certain circumstances (usually limited to 2 or 4 years); c) students with F, J, M or Q Visas who meet certain requirements or d) professional athletes who are present to compete in a charitable event.
Foreign nationals who spend time in the United States should keep carful track of their days travelling in the U.S., as these are required to be reported on Form 1040NR in addition to being used in determining the presence test mentioned above and the amount of income earned in the U.S.
Elective Residents: In certain circumstances a foreign national who otherwise would be classified as a NRA may elect to be treated as a resident alien. To do so they must meet certain requirements including:
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The person cannot have been treated as a U.S. resident alien in any prior year
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The requirements for the substantial presence test must be satisfied in the year immediately following the election
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The individual must be present for at least 31 days in the arrival year
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The person must be present in the U.S. during the arrival year at least 75% of the days from the beginning of the 31 day count and the end of the calendar year.
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The election cannot be made until the substantial presence test has been met in the subsequent year. Thus in certain circumstances a person electing first year tax residency may need to file for an automatic 6 month extension to file their income tax return.
For U.S. tax purposes the effective date of U.S. residency may vary depending on facts and circumstances. For example, the person making the first year election for be considered as being a U.S. tax resident the first day of the of the earliest 31 day period included in the continuous presence period. A foreign national who was not a U.S. tax resident in the immediately previous year will be deemed a U.S. tax resident on the first day physically present in the U.S. in the year that the substantial presence test is satisfied.
As you can see, it is possible for a foreign national to be both a non resident alien (Filing Form 1040NR) and a resident alien (Filing Form 1040) during the year. Such a person is said to be filing a Dual Status Return. In the first dual status year, where the individual is a U.S. tax resident at the end of the year, the form filed is Form 1040 (as a Dual Status) with a Form 1040NR as an attachment to report U.S. source income during the period of non residency. In the exiting year, the individual may cease being a U.S. tax resident during the year, but also have income from U.S. sources during the subsequent period of U.S. non residence. In such a situation the person files Form 1040NR as a Dual Status with a Form 1040 as an attachment.
U.S. Income Taxation of Non Resident Aliens (NRA)
Effectively Connected Income
Normally a person who is not a tax resident (either a permanent resident <green card holder>, someone who has met the “substantial presence test” or U.S. citizen) is considered to be a non resident alien and will be taxed only on income that is from U.S. sources at the rates that apply to that income pursuant to the tax code (or lesser treaty rates), depending on the nature of the income. U.S. sourced effectively connected income is taxed at graduated rates. Income, including U.S. sourced non effectively connected income is taxed at rates either established by US tax law or at a lower rate pursuant to an income tax treaty.
In the majority of cases, as regards international assignees, effectively connected income is derived from services performed within the U.S. such as wages or income from self employment. Income of this nature is taxed at graduated rates. If the foreign national assignee works for a U.S. based company, their compensation will be reported to the United States and taxes that are withheld will be paid to the U.S. and applied as a credit when the individual files his or her income tax return. There will be times, however, when the foreign national is employed by a foreign corporation, often the parent company, and make business trips to the U.S., either for special projects or to meet or discuss matters such as a future transfer. In some situations, although the services are performed in the U.S. and therefore considered as U.S. source income, as the compensation is paid by the foreign employer it will not be reported to the IRS and there will be no income tax withheld. This does not excuse the non resident foreign national from paying U.S. income tax on the earnings, even if tax is paid to their home country. However if the employee is a resident of a country with which the U.S. has a tax treaty, the threshold for not being subject to U.S. income tax is usually 183 days, however this may vary depending on the actual treaty. Also, if the individual is in the U.S. for less than 90 days, works for a foreign employer and receives compensation of less than $3,000 he or she is also exempt form paying U.S. income tax.
Non-Effectively Connected Income
Income from U.S. sources that is not exempt and not considered ECI, and is received by foreign nationals who are not U.S. tax residents will be taxed at a fixed rate (usually 30% without deductions) depending on the nature of the income received. The rate may be reduced based on tax treaty provisions. Portfolio interest income and non-effectively connected capital gains income received by a NRA foreign national is not subject to U.S. income tax under U.S. tax law, however capital gain income from the sale of property located in the U.S. may be subject to special rules under the Foreign Investment in Real Property Tax Act (FIRPTA). A foreign national who is a partner in a U.S. partnership that receives capital gain income (other than from real property) will be subject to withholding at a rate of 15% relating to ECI capital gains from U.S. property sales.
NRA foreign nationals file Form 1040NR if they owe income tax or are due a refund, however if their U.S. sourced income is sufficiently covered by 30% withholding tax, it may not be necessary to file a U.S. income tax return.
Personal Service Income
As previously mentioned, determining if income is considered U.S. source is made on the basis of where the services are performed, not with regard to where the money is received or from whom it was paid. A nonresident alien who is compensated by a foreign employer for services performed in the U.S. is deemed to have earned U.S. sourced personal service income, which is taxed by the U.S. at graduated rates. There are certain statutory exceptions to this rule as well as treaty exceptions.
Compensation for services performed in the U.S. for non U.S. employers (or income from self employment) is not considered as being U.S. Source if:
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The service is performed by a NRA temporarily present in the U.S. for less than 90 days.
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The remuneration is not greater than $3,000
Certain treaties may entitle a foreign person to work in the U.S. for a foreign employer (or self employed) for a longer period of time or earn an amount greater than $3,000.
U.S. Income Tax Considerations for NRAs on Temporary Assignment in the U.S. Working for a U.S. Company
Deducibility of Away From Home Expenses
Foreign nationals temporarily assigned in the U.S. may be able to deduct non reimbursed travel, meals and lodging expenses incurred while on business away from their tax home. Tax home is a concept that pertains to the location that the person customarily works at, regardless of their residence. A person who’s tax home is, say Germany, and temporarily assigned to a U.S. company for less than 183 days is considered a non resident for U.S. tax purposes (absent the provisions of the substantial presence test). Often the foreign employer may pay for travel expenses to and from the United States, but often a travel allowance is paid as a component of the compensation package. To the extent that the expenses for meals, lodging, local business travel, telephone, local transportation, utilities, laundry, etc. are reasonable, ordinary and necessary, incurred in connection with the assignment in the U.S. and the person is considered to be temporarily away from their “tax home” these expenses are deductible in determining taxable income on Form 1040NR. In order to be away from their tax home, the person’s tax home needs to continue in the same foreign location (ordinarily the person’s home country) and the assignment in the U.S. must be temporary. Employment in any one location for more than one year is not, under any circumstances, considered as being temporary. Under certain circumstances, even if the person is otherwise considered as a U.S. tax resident under the substantial presence test, under certain provisions of some international tax treaties often referred to as “tie breaker rules” an individual may be in the U.S. for more than 183 days but less than a year and still be subject to tax in their home country. In such a case the person would be entitled to deduct away from home living expenses. Also, in order to be deductible, the expenses need to be substantiated. As regards meals, in the absence of receipts or other substantiation, the IRS will allow a per diem allowance based on the travel location within the U.S.
Note that if a non resident
alien travels outside the United States on business during their temporary
assignment period, the income earned for services performed outside the U.S. are
not subject to tax, and thus away from home expenses are not allowed. In
addition to receipts, the person should maintain a diary in order to keep track
of days worked in and out of the U.S. and expenses attributable to those days
which are also backed up by the person’s passport. Note that application for a
permanent residency visa may be grounds for disallowing temporary away from home
living expenses.
U.S. Income Taxation of Resident Aliens
In general, a resident alien is entitled to all of the same tax benefits to which any other U.S. tax resident can claim; however a resident alien is also required to include all worldwide sources of income on their U.S. income tax return. A non resident alien, however, is only required to include and pay income tax on income from sources within the United States. A U.S. resident reports income and claims deductions using Form 1040.
As previously discussed, there are situations when a foreign national is considered a Dual Status resident, where the individual is considered as a non resident alien for part of the year but a resident alien as of December 31. In this situation the rules pertaining to non resident aliens will apply during the first part of the year while the person is a non resident alien and change once the individual is categorized as a resident alien during the year. Also, in certain circumstances, an election may be made to file as a resident alien for the entire year.
Probably the most important thing to remember is that as a resident alien, which can be the result of obtaining lawful resident status (a green card), or meeting the substantial presence test, is that the taxpayer is required to include their worldwide income in their income tax return and are entitled to all deductions, exemptions and credits that are permitted under U.S. tax law. Once a person becomes a resident alien for U.S. tax purposes, the status remains until one of the conditions previously mentioned occurs.
Unlike a non resident alien, a resident alien is permitted to file a joint income tax return with their spouse, provided that certain conditions are met. This is accomplished by making a one time election (by the spouse) to be included as a joint filer and agrees to include his or her worldwide income. Once made the election is binding for all future years. If the election is not made, the filer must file as married, filing a separate return from their spouse.
Some of the conditions that are required is that in order to file a joint tax return with a non working souse without a social security number, the spouse must obtain a Individual Tax Identification Number (ITIN). In order to claim dependent children as exemption deductions, an ITIN must also be obtained for each child as well. The IRS has simplified the process of obtaining an ITIN for a non working souse and children by including the appropriate forms (W-7) along with the Form 1040 filed for the year in which either the joint return election is made or the children are claimed as dependents. The return must also include other required documentation and information and be filed with the appropriate IRS office in Austin, Texas.
Note that the ITIN does not provide employment privileges which would require that one obtain a U.S. social security number.
To avoid double taxation of income, the resident alien taxpayer may claim a credit for foreign taxes that may be paid on income from sources outside the United States. There are also certain provisions that exist pursuant to certain international income tax treaties where should a foreign national be considered a resident of a foreign country in addition to being classified as a U.S. resident, whereby certain income subject to tax outside the U.S. is not required to be reported on the U.S. income tax return.
Social Security Taxes
In general every person who is employed by a U.S. employer is subject to paying into the U.S. social security system, regardless of whether or not they will be eligible to collect benefits. In certain circumstances where the U.S. has a “totalization” agreement in effect with the person’s home country, there may be exceptions to this rule. For example, if a person is a citizen of Germany the German national may work for a U.S. affiliate of a German company and elect to contribute to the German social security scheme instead of the U.S. social security scheme. This election may only be made for the first 5 years, after which the person is required to participate in the U.S. social security system. It is important to note that in order to receive retirement benefits, a German citizen is required to have been deemed employed (and contributed to the U.S. social security system) within the U.S. for at least ten years. The totalization agreement provides that if a German national contributes to the U.S. social security system for 6 quarters (1 ½ years) during a ten year person during which they worked in the U.S., that person shall be deemed to have contributed to the U.S. system the entire time. In effect, the money contributed to the German system is counted as having been contributed to the U.S. system. In such a situation, it may be possible for an individual to collect benefits from both countries once they reach retirement age. Alternatively, they may elect to receive benefits from only one country.
Contributions to either a foreign or U.S. social security retirement pension system are not deductible for U.S. income tax purposes, and being a regressive tax, there are no deductions permitted against gross employment income to reduce that income that is subject to social security tax. However, contributions made to a U.S. or foreign health care system are deductible (subject to certain income limitations) against income in determining income taxable by the U.S. for income tax.
In view of the recently enacted health care bill, all U.S. persons will be eventually required to maintain health care coverage, and employers mandated to provide coverage. Presently there is considerable debate as to whether or not this would apply to employees of foreign companies or U.S. affiliates of foreign countries, as many foreign nationals may choose to contribute to and be covered by the system of their home country.
Foreign Bank Account Reporting (FBARs): All U.S. residents are required to report to the U.S. treasury department (using Form TDF 90-22.1) foreign bank accounts which they either own, have control over or have signing authority for, if the balances (for all accounts combined) at any time during the year exceeds$10,000. This is a U.S. Treasury and not an income tax requirement, and it applies even if there is no income from the accounts or if foreign taxes are paid on the account and if the income related thereto is reported on the person’s income tax return. The form is required to be filed (and received by the U.S. Treasury Department) no later than June 30 of each year. The maximum potential monetary penalty for not filing this form voluntarily on time is $10,000 per form, per year. In addition, failure to file this report and not include the foreign income on one’s personal income tax return may subject the person to criminal prosecution and sanctions.
Sources of Income Subject to U.S. Income Tax
Sourcing of income is a concept based not where the income is received, but rather from where it is earned. Passive income, such as investment income, is sourced based on where the income is attributed, which is usually where the assets earning the money is located. Dividends or capital gains from stocks invested in the U.S. and paid by a U.S. company or investment fund, would be considered as U.S. source income and taxable by the U.S. The rates and amount of tax, if the income were fixed and determinable, would be 30% or lower rate depending on the treaty countries involved. To avoid tax avoidance by persons residing outside the U.S., or having the money deposited to their foreign bank account, income tax is withheld at source at the time it is paid.
Income paid by partnerships or real estate trusts is taxed, and subject to withholding based, not on the amount actually distributed, but on the amount earned-even if it is not distributed. Thus, a partner or member of a Subchapter S corporation will pay tax on income earned by the entity, even if not distributed. Similarly a deduction may be available for business entity losses provided that the losses do not exceed the person’s tax basis in the business entity.
Other income is taxable when paid, such as interest or dividends.
Income tax on income tax is effectively connected with business activities in the U.S. is determined based on where the services are performed or where the assets earning the income are located. Thus, compensation, regardless if it is deposited to a foreign bank account, is considered as being U.S. sourced ECI and subject to tax (by an individual) at graduated rates.
Things that are important to remember, is that if foreign sourced income is taxable in the U.S. (say be a resident alien) and is also taxed by a foreign country, it may avoid, or mitigate the effects of double taxation by applying a credit for foreign income tax paid. Note that only income foreign taxes maybe used as a credit and taxes that are not attributable to income (such as estate, value added, luxury, or social benefits or pension) may not be included with foreign income taxes paid for purposes of determining the income tax credit.
Remember that non resident aliens are required to report and pay tax only on U.S. sourced income, while resident aliens are required to include on their income tax returns all income, from all worldwide sources (unless it is exempt by law).
U.S. Tax Considerations for Years Entering or Leaving the U.S.
Beside the immigration laws, a person entering or leaving the United States needs to be aware of the U.S. tax laws. Paramount is determining whether the individual is a non resident, resident or part year resident. To best understand these rules let’s look at some examples.
Entering the U.S.
Example 1: Assume that you are a citizen of Germany and temporarily assigned to work on a special project in the U.S. The first thing you need to do is review the U.S. tax laws and the income tax treaty between Germany and the United States. If your assignment is for a period of less than 183 days you will probably pay income tax to Germany on that income and be exempt from tax in the United States on your U.S. sourced compensation. Most likely you will be compensated by your employer in Germany, even though you are performing the project at the location of the U.S. affiliate of the German employer. In this situation you will not need to file a U.S. income tax return unless you have other U.S. sourced income subject to U.S. tax and owe tax or are entitled to a tax refund. As in this situation the person is not employed by a U.S. company, it is not necessary to obtain a U.S. social security card; however if the person is filing a Form 1040NR for one of the reasons mentioned, it will be necessary to obtain an ITIN.
Example 2: The individual is assigned to the U.S. to work on a special project which lasts for more than 183 days which extends beyond December 31. The first day that the person was present for 31 consecutive days was May 1; however the person spends 20 days in the U.S. working for his or her foreign employer between January 1 and April 30. As the period of residency under the substantial presence test begins as of the first day beginning the 31 consecutive day period (May 1), this person will file a “dual status return” which in this case is Form 1040 marked “Dual Status” with a Form 1040NR as an attachment to the return. The U.S. compensation income earned between January 1 and April 30 will be included in the Form 1040NR and taxed at regular graduated rates, however the person will not be entitled to deductions otherwise provided to a resident during this period, and if married will file as a married person filing a separate tax return from their spouse. Unearned U.S. sourced income will be taxed pursuant to the U.S. tax laws applicable to a non resident alien during this period. Non U.S. sourced income is not reported or subject to U.S. tax during this period. However, effective May 1, the person becomes a U.S. resident. This means that the person is taxed on their worldwide income and entitled to U.S. tax benefits available to a U.S. resident. However, in order to file a joint income tax return with their non resident alien spouse, a special one time binding election is required as previously mentioned.
Example 3: The person began the special project for the U.S. affiliate of the German employer on September 30, 2007. In 2007 they obtain a U.S. social security card and receive a Form W-2 from the U.S. employer. They continue to work for the U.S. employer (German company affiliate) throughout 2008. They may either file a Form 1040NR as a non resident alien in 2007 (as they spent less than 183 days in the U.S.) or wait until they meet the substantial presence test in 2008 and then file a dual status resident return for 2007. Either way, they are a resident of the U.S. for U.S. tax purposes for 2008.
Now there are provisions in model tax treaties such as with Germany and the U.S. known as tie breaker rules which involve “closer connection”, as well as other closer connection tax statutes where an individual may meet the substantial presence residency test but because they have a closer connection with their home country and are required to pay tax in their home country as a resident, they may file a Form 1040NR as a non resident alien and report only that income which is U.S. sourced ECI. These situations are uncommon but need be mentioned.
Example 4: The German national is present in the U.S. for less than 183 days in 2010 but gets lawful immigration status on September 1, 2010. That person will file a dual status resident income tax return for 2010 reporting U.S. sourced income received through August 31 on schedule 1040NR and filing Form 1040 (Dual Status) as their 2010 U.S. income tax return, reporting income from September 1 through the end of the year on Form 1040 and being subject to U.S. tax residency.
DUAL STATUS RETURNS One may wonder if Form 1040NR is used as a schedule to Form 1040 to report income not reported on Form 1040, and therefore the Form 1040 tax liability is not computed, how one reports the tax liability on Form 1040. The tax liabilities for both the Forms 1040NR and 1040 are added together and reported as the total tax liability due on Form 1040.
It is also important to note that when calculating the U.S. income tax liability on U.S. sourced personal service income, the income earned both during the period of non residency and residency are combined in order to determine the proper tax rates and tax liability.
Exiting the U.S.
Once a person becomes a tax resident of the United States, their status remains as such until either they are no longer a lawful immigration resident (Green Card holder) or they leave the United States without returning. Therefore so long as they retain their Green Card residency status they are required to file as U.S. tax residents of the United States. If they are subject to tax in another country, a credit is permitted against the U.S. tax liability for taxes paid to a foreign taxing authority. If they hold lawful U.S. permanent residency status, they may be entitled to the foreign earned income exclusion of they leave the U.S. to reside and work overseas. Remember as a U.S. tax resident one is responsible for reporting and paying U.S. tax on worldwide income from all sources.
Should a person with lawful immigration status choose to surrender their Green Card, or otherwise leave the U.S. permanently without intent to return, they need to get tax clearance from the IRS (also known as a “sailing permit”) in order to avoid being subject to U.S. tax after they have left the U.S.
In the year that the person exits the U.S. without intention of returning, either a final return is filed as a resident or a dual status Non Resident Alien Return is filed. If the person leaves say on March 1, obtains appropriate tax clearance, etc. they will file a U.S. resident Form 1040 for the period January 1 through March 1, 2010. However if the person is subsequently required to return to the U.S. on a short term business trip, or has other U.S. source income which must be reported, they file a Form 1040NR with an attachment that includes Form 1040. The tax liability from both returns is added together and reported as the total tax liability on Form 1040NR.
It is also important to note that when calculating the U.S. income tax liability on U.S. sourced personal service income, the income earned both during the period of non residency and residency are combined in order to determine the proper tax rates and tax liability.
Another important concept is that of “constructive receipt”. If a person who is a resident alien receives a check for non U.S. personal services or income otherwise not taxable to a non resident alien while that person is a resident alien of the U.S., but cashed the check after becoming a non resident alien, the income is still taxable to the U.S. under the constructive receipt doctrine.
Other issues may involve the sale of a the persons principal personal residence at a gain either located in a foreign country or in the U.S. These rules can become somewhat complex and accordingly, not discussed herein, and competent U.S. tax advice should be sought. However, consideration should include if the house is sold at a when the person is a U.S. tax resident or non resident, what the rules regarding the sale of real property located in the U.S. are, the period of time that U.S. or foreign real property is used as a primary personal residence, etc.
Annuities, Pensions, and Other U.S. Tax Rules
After a person has lived and worked in the U.S. for some time, he or she may have become involved in different investments both within the U.S. and without. All of these need to be carefully considered when leaving the U.S. and becoming a non resident alien individual.
U.S. taxation of pension or annuity income received by a non resident alien can get a little tricky. The first place to check is the treaty to determine if special rules exist as regards pension payments made by either a U.S. or foreign employer that is attributable to services performed inside the United Sates. If there is no treaty provision, the portion of the pension received by a NRA is attributable to that portion that is attributable to services performed within the United States.
Several
other rules exist as regards non U.S. persons who have abandoned their U.S.
residency but continue to receive U.S. source income. One example is if the
person was a member of a U.S. LLC, partnership or other business organization
and that business continues to receive installment payments attributable to the
sale of U.S. intellectual or personal property. Although the person may no
longer be a U.S. resident, the income earned by the U.S. entity (say an LLC) in
the form of installment payments would be taxable to (and subject to U.S.
withholding tax) during the year when the income is earned, regardless of
whether or not it was distributed.
Immigration Visas
Please note that this discussion of U.S. visas is considered as general information and not legal advice. Specific information should be sought from a U.S. attorney who specializes in U.S. immigration law.
Generally there are two general categories of visas, immigration and non immigration visas. All persons attempting to enter the United States are presumed to intend to remain here indefinitely, and subject to certain legal classifications, unless they can show that they are exempt pursuant to certain classifications or entering the United States for temporary purposes (for which there are also different classifications)
Unless otherwise specifically exempt, all persons attempting to enter the U.S. must obtain the necessary visa from the U.S. Counselor’s office. This is usually most easily accomplished at the office where the person resides in their home country.
There are a variety of different visa classifications and we will not attempt to address all in this context, but will address some.
B Visas- These are temporary visitation visas usually good for only 6 months. A B-1 visa is for business, and a B-2 for pleasure. Under certain Visa Waiver Programs with certain countries, visitors and tourists can enter the United States for no more than 90 days without a Visa; however it is suggested that this be cleared with the local U.S. counselor’s office.
H Visas- These are temporary workers and are further classified based on the nature of occupation, education and specialization, and are often subject to quota restrictions as well as the amount of time that the visa is valid. H-1A visas are issued to nurses working temporarily in the U.S. and H-1B visas to other professions. Most H-1 visas are good for a maximum of 6 years. The application process begins with the prospective employer filing with the Department of Labor and petitioning the U.S. INS. If approved, the employee then applies for the Visa with the nearest U.S. Consulate office.
Trainees seeking to participate in established structured training programs may be issued an H-3 visa (good for 18 months) and dependent spouses and children of approved H visa holders may receive an H-4 visa at the discretion of the Consulate.
I Visas are issued to members of the international media, often subject to reciprocal arrangements, and often valid for an extended period of time.
J Visas are issued to exchange visitors and their spouses, often trainees sponsored by an organization or institution that is chartered by the U.S. State Department. These are usually valid for between 12 and 18 months.
L Visas are issued to certain executives and their spouses with specialized knowledge who are transferred to the U.S. to work for their employer. The application process starts with the employer petitioning the INS in the United States and if approved, the visa application with the local consulate. The visas issued to managers and executives (and their spouses) are usually valid for 7 years and those issued to specialized knowledge workers 5 years.
TN Visas – These are specialized worker status visas issued pursuant to the 1998 NAFTA agreement between the U.S., Canada and Mexico which permits free entry and exit status for certain professionals between the three North American Continental countries. Most are one year renewable visas.
U.S. Individual Income Tax Rates
In 2001 the U.S. 107th Congress established changes to the income tax laws intended to stimulate the economy. In order to get this tax legislation passed, the provisions of this 2001 tax act contained what is referred to as a “sunset” provision, meaning that unless a future Congress extended the tax provisions, including the new marginal tax bracket rates, the law would revert to where it was prior to the 2001 tax changes.
So far, no U.S. Congress, including the existing 111th Congress has yet to either change of otherwise extend the provisions of the 2001 tax act, including the marginal personal tax provisions. This leaves a significant amount of uncertainty as regards tax planning for 2011, and given the hardships of the U.S. and global economy combined with anticipated changes in the 112th Congress based on the 2010 midterm elections, it is impossible to predict at this time what changes to tax legislation will, if any, be made either before the end of 2010 or early in 2011, retroactive to the first of the year.
Tax “experts” have been anticipating that the 111th Congress will make a last minute “extension” of the 2001 tax provisions before the end of the 2010 year, at least until anticipated changes can be studied.
Under existing tax law U.S. individuals have six (6) marginal tax brackets (10%, 15%, 25%, 28%, 33% and 35%), with each of the six percentages being applicable based on the filing status of the individual. Unless the 2001 tax law is extended, the number of marginal rate brackets will revert to 5 (15%, 28%, 31%, 36%, and 39.6%) with each rate being applied at a much lesser income bracket range.
The IRS has just released the 2010 marginal tax brackets:
Single Individuals
10% on income between $0 and $8,375
15% on the income between $8,375 and $34,000; plus $837.50
25% on the income between $34,000 and $82,400; plus $4,681.25
28% on the income between $82,400 and $171,850; plus $16,781.25
33% on the income between $171,850 and $373,650; plus $41,827.25
35% on the income over $373,650; plus $108,421.25
Married Filing Jointly or Qualifying Widow(er) Filing Status
10% on the income between $0 and $16,750
15% on the income between $16,750 and $68,000; plus $1,675
25% on the income between $68,000 and $137,300; plus $9,362.50
28% on the income between $137,300 and $209,250; plus $26,687.50
33% on the income between $209,250 and $373,650; plus $46,833.50
35% on the income over $373,650; plus $101,085.50
Married Filing Separately Filing Status
10% on the income between $0 and $8,375
15% on the income between $8,375 and $34,000; plus $837.50
25% on the income between $34,000 and $68,650; plus $4,681.25
28% on the income between $68,650 and $104,625; plus $13,343.75
33% on the income between $104,625 and $186,825; plus $23,416.75
35% on the income over $186,825; plus $50,542.75
Head of Household Filing Status
10% on the income between $0 and $11,950
15% on the income between $11,950 and $45,550; plus $1,195
25% on the income between $45,550 and $117,650; plus $6,235
28% on the income between $117,650 and $190,550; plus $24,260
33% on the income between $190,550 and $373,650; plus $44,672
35% on the income over $373,650; plus $105,095
Estimated Income tax brackets for 2011 as adjusted for inflation
The following is an estimate of how the 2011 tax brackets may look for 2011 unless either the 2001 tax legislation is continued or changes are made:
Single Individuals
15% on income between $0 and $35,020
28% on the income between $35,020 and $84,872; plus $5,253
31% on the income between $84,872 and $177,006; plus $19,212
36% on the income between $177,006 and $374,860; plus $47,773
39.6% on the income over $384,860; plus $122,601
Married Filing Jointly or Qualifying Widow(er)
15% on income between $0 and $70,040
28% on the income between $70,040 and $141,419; plus $10,506
31% on the income between $141,419 and $215,528; plus $30,492
36% on the income between $215,528 and $384,860; plus $53,466
39.6% on the income over $374,860; plus $114,425
Forms Used By Foreign Nationals
Form I-9: Within three days of hiring every employer is required to determine the immigration status of an employee and their right to work. This involves both the employer and the employee completing Form I-9 and the employee is required to provide proof of identity and entitlement to work. This form must be kept on file by the employer for three years.
Form W-4: Every new employee is required to complete and provide to the employer Form W-4 providing the name, address, social security number and filing status/dependents or additional tax withholding requested by the employee.
Social Security Coverage Requests : Every employee working for a U.S. employer is required to contribute to the U.S. Social Security fund, and every employer is required to contribute an equal amount. However, to avoid double taxation or loss of benefits, the United States has entered into what are called Tax Totalization social welfare agreements with various countries. Workers who are exempt under such an agreement must document this by providing the employer with a Certificate of Coverage which they must obtain from their local social services bureau in their home country.
Form W-2-Annual employer’s report of employee earnings and taxes withheld
Form W-3-Employer’s annual transmittal of Forms W-2 to Social Security
Form 1042-S-Report to payee of U.S. source income (other than wages) and taxes withheld.
Form 1042-Payer’s annual report of Forms 1042-S
Form 1042-T: Annual transmittal of Forms 1042-S
Form 8813-Partnership remittal voucher for income taxes withheld from foreign partner earnings.
Form 8804-Annual partnership return of income reported and taxes withheld for foreign partners
Form 8805-Report to foreign partner of
taxable income and withholding from U.S. partnership
U.S. Tax Treaties
As mentioned throughout this booklet, the United States has entered into both income tax and social security (totalization) treaties with numerous countries. Information concerning income tax treaties, including reduced rates on portfolio dividends, interest, royalties, special exemptions, tie breaking rules, and information regarding personal service income, etc., can be found in IRS Publication 901 which is available on the internet at www.irs.gov. This publication includes the basics of the treaties that exist with each country. Entire copies of each treaty are available as well.
Information regarding social security tax, including totalization agreements pertaining to contributions and benefits, can also be found on the web at www.ssa.gov
U.S. Tax Withholding
In general, income earned and paid (either constructively or directly) to U.S. individual taxpayers (both foreign and domestic) is usually subject to U.S. income tax withholding at source (by the payer).
Wages paid by U.S. employers to employees is subject to regressive withholding of Social Security and Medicare tax plus income taxes (federal and local) determined based on the information provided by the employee on Form W-4 as regards marital filing status, exemptions, etc. This information is reported on Form W-2 which is required to be filed by January 31 of the year immediately following the year in which the wages were paid.
U.S. source payments made to foreign non resident aliens, other than wages paid to foreign employees on a U.S. payroll is also subject to withholding at source. This includes interest, dividends, capital gain distributions, royalties, payments made for personal services and income of other natures. The amount if income tax withheld, although usually30% by law, is often reduced if an income tax treaty exists between the recipient’s home country and the U.S. The income paid and taxes withheld are reported to the individual on Form 1040-S, which includes codes identifying the nature of the income, and any exemption or treaty information that may apply. All Forms 1042-S are required to be transmitted to the IRS along with Form 1042-T by the 15th day of the third month following the end of the calendar year.
Non Tax Considerations
During our interviews with executives from European nations we found that many were surprised to learn of the cultural differences between their home country and the United States. As these often have a direct impact on the cost of living in the United States as compared to some other countries, one needs to consider the concept of net disposable income, not only from a tax perspective, but taking into consideration differences in the cost of living.
One example of such differences may be the cost of living expenses such as water and other utilities as well as television broadcasting, in addition to the cost of housing and health care.
Prior to accepting an assignment in the United States the prospective assignee needs to consider the anticipated differences in living costs as well as income taxation. As regards projected income taxation, it is best to retain the services of a competent tax advisor prior to the move and prior to negotiating a final contract as regards estimating the cost of U.S. income taxation against your base salary and bonus as well as any foreign service allowance. We have found that one of the best means of determining cultural and living cost differences would be to discuss these with a co-worker who previously relocated from your home country and location.
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