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U.S. Income Taxation of Nonresident Alien Individuals (Portfolio 907)

Tax Management Portfolio, U.S. Income Taxation of Nonresident Alien Individuals, analyzes the U.S. income tax laws applicable to non-U.S. citizens (i.e., “aliens”) who are classified as “nonresident aliens” rather than as “resident aliens” under the Internal Revenue Code.

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DESCRIPTION

To the extent that nonresident aliens are subject to U.S. income tax, their U.S. taxable income is divided into one of two categories: U.S.-source income that is not “effectively connected” with the conduct of a trade or business within the United States, taxable at the rate of 30% under §871(a) without the allowance of deductions, and income that is “effectively connected” with a U.S. trade or business, taxable at graduated rates on a net basis under §871(b). However, numerous special exceptions and rules apply for specific types of income.
Whether an alien is classified as a “resident alien” or a “nonresident alien” is based on detailed rules in §7701(b) and the regulations thereunder. For the most part, these rules are “mechanical,” so that in most factual situations it is possible to know with certainty whether a particular alien is a resident alien or a nonresident alien on a particular day. The rules in §7701(b) may be overridden by the “tie-breaker” provisions of a tax treaty, however, where it is shown that an alien is also classified as an income tax resident of another country having an income tax treaty with the United States.
If a nonresident alien realizes U.S.-source income subject to tax on a gross basis, payments related to that income are normally subject to withholding tax at a 30% rate under §1441. Where a nonresident alien is taxable on a net basis on income that is effectively connected with a U.S. trade or business, he must file a federal income tax return on Form 1040NR. The calculation of his taxable income and of his tax is similar to the rules for U.S. citizens and resident aliens, but with certain important differences. Special rules can apply where an alien comes to the United States to work, becomes a resident, and later receives deferred compensation or pension income from the United States after moving abroad and resuming nonresident alien status.
Many nonresident aliens who are present in the United States and who plan to depart from the United States are required to make a personal visit to an IRS office and apply for a so-called “tax clearance certificate” (or “sailing permit”).
Special rules are applied under §877A to certain U.S. citizens who give up their citizenship and become nonresident aliens, and also to certain long-term immigrant aliens who give up their U.S. immigration visa and become nonresident aliens. In many cases tax is imposed on the unrealized gain inherent in the value of the individual's worldwide assets.
A special non-tax reporting form (Form TDF 90-22.1) may be required to be filed with the U.S. Treasury Department by resident alien individuals who have foreign bank accounts and similar financial accounts. The IRS has temporarily waived this requirement for all nonresident aliens, but could require filing of this form from many of them in the future.
Finally, a separate albeit similar reporting form (Form 8938) may also be required to be filed with the IRS by certain nonresident and resident alien individuals who file an income tax return and have interests in specified foreign financial assets the value of which exceeds an applicable reporting threshold.


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AUTHORS

U.S. Income Taxation of Nonresident Alien Individuals was authored by the following experts.
THOMAS S. BISSELL, CPA
Thomas S. Bissell, B.A., Harvard College (1964); LL.B., Columbia Law School (1967); LL.M. in Taxation, New York University (1971); Member, New York Bar (retired status); Certified Public Accountant, State of Florida; Member, Tax Management U.S. International Advisory Board, American Bar Association; former Attorney-Advisor, Office of International Tax Counsel, U.S. Treasury Department, Washington, D.C.; retired tax partner, Coopers & Lybrand LLP (a predecessor firm of PricewaterhouseCoopers LLP); author of numerous articles in professional tax publications.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

II. Historical Background

III. Determination of Resident Alien Status

A. "Resident Alien" Status Prior to TRA 1984

B. Resident Alien Status under § 7701(b) - An Overview

1. General Definitional Rules

2. Expansiveness of the Regulations

3. Tax Treaty Overrides

4. Non-Immigrant Visa Categories

5. Scope of § 7701(b)

C. The Permanent Residence (Green Card) Test

1. General Rule

2. Revocation of Green Card Status

3. Abandonment of Green Card Status

D. The Substantial Presence Test

1. General Rules

2. The Daycount Rules

3. Meaning of the Term "United States"

4. No-ruling Area

E. Special Exceptions to the Substantial Presence Test

1. Overview of the Exceptions

2. Less Than 183 Days in U.S. in the Current Year

a. General Rule

b. "Tax Home" Test

(1) No Tax Home, or Multiple Business Locations

(2) Alien Who Moves from One Foreign Country to Another

c. "Closer Connection" Test

d. Disclosure Requirement - IRS Form 8840

3. Foreign Government-Related Individuals

a. Employees of Foreign Governments

b. Employees of International Organizations

c. Immediate Family Members

4. Teachers and Trainees (J-Visa and Q-Visa Holders)

a. General Rules

b. Time Limits

c. Disclosure Statement

5. Students

a. General Rules

b. 5-Year Time Limit

c. Disclosure Statement

6. Professional Athletes in Charitable Sporting Events

7. Aliens with a Medical Condition

a. General Rules

b. Disclosure Statement

8. Regular Commuters from Canada and Mexico

9. Aliens in Transit Through the United States

10. Foreign Vessel Crew Members

F. Resident Alien Election

IV. Resident Alien Starting Date and Termination Date

Introductory Material

A. Residency Starting Date Rules

1. Starting Date under the Permanent Residence (Green Card) Test

2. Starting Date under the Substantial Presence Test

3. Starting Date If a Resident Alien Election Is Made

B. Residency Termination Date Rules

1. Termination Date under the Permanent Residence (Green Card) Test

a. General Rule

b. Former Long-term Residents

2. Termination Date under the Substantial Presence Test

C. The "No Lapse" Rule

D. Joint Return Election under § 6013(g) and (h)

1. General Rules

2. Combining a § 7701(b)(4) Election and a § 6013(g) or (h) Election

V. Interplay of Income Tax Treaties with § 7701(b)

A. Treaty Tie-Breaker Rules

B. The IRS Regulations

1. Nonresident Alien for Most Purposes

2. Disclosure of Status to IRS

C. Categories of Aliens Affected by the Tie-Breaker Rules

1. Non-Immigrant Aliens with a U.S. Presence

2. Green Card Holders Living Abroad

D. Effect of Tie-Breaker Status on Residency Time Periods

E. Treaty Rules and § 6013(g) and (h) Elections

F. Special Rules for S Corporations

G. "Saving Clause" in Tax Treaties

VI. Income Taxation of Nonresident Aliens - General Rules

A. "Business" vs. "Non-Business" Income

B. "Effectively Connected Income" (ECI)

1. General Rules

2. Whether the Alien Is "Engaged in Trade or Business within the United States" (ETBUS)

a. Employees

b. Self-Employed Personal Service Providers

c. Investors

3. "Deemed" ETBUS Status

a. FIRPTA Rules on Gains from U.S. Real Property

b. Payments Deferred into a Non-ETBUS Year

c. Sale of ETBUS Assets in a Later Year

d. Real Property Net Election under § 871(d)

4. Determining Whether Gross Income Is ECI

5. Deductions Allowed in Determining Net ECI

a. Expenses Connected with ECI

b. Allowable Deductions Not Connected with ECI

c. No Standard Deduction

6. "No Deduction" Rule If Timely Return Is Not Filed

a. General Rules

b. Tax Treaty Implications

7. Withholding at Source on ECI

C. Non-Effectively Connected Income

1. Tax on "FDAP" under § 871(a)(1)

a. General Rules

b. Tax Treaty Overrides of § 871(a)(1)

c. Withholding to Enforce Collection of Tax on FDAP

d. Additional Special Categories of Income

2. Tax on U.S.-Source Capital Gains under § 871(a)(2)

a. General Rules

b. Treatment of Losses

c. Tax Treaty Overrides of § 871(a)(2)

d. Withholding and Information Reporting under § 871(a)(2)

e. Dual-Status Aliens

D. Treaty-Based Return Position Disclosure

VII. Calculation of Taxable ECI

A. Introduction

B. Gross Income

1. Only U.S.-Source Compensation Is Taxable

2. Employees - Elements of an Alien's Compensation Package

a. Moving Expense Reimbursements

b. Reimbursement of U.S. Housing Costs

c. Other Temporary U.S. Living Expenses

d. Company Car

e. Tuition Reimbursements

f. Home Leave Reimbursements

g. Tax Reimbursements

h. Home Country Pension Plan Contributions

i. Coverage under Group Insurance Plans

3. Self-Employed Aliens

C. Adjustments to Gross Income

D. Itemized Deductions

VIII. Tax Return Filing Procedures

A. Introduction

B. Requirement to File

1. Alien Is ETBUS

2. Tax Is Owed for the Year

3. Treaty Tie-Breaker Aliens

C. Structure of Form 1040NR

D. Reporting of FDAP on Which Withholding Was Sufficient

E. Taxable Year of a Nonresident Alien

F. Filing Status

G. Calculation of Tax

1. Tax Credits

2. Alternative Minimum Tax (AMT)

H. Questions on Page 5 of Form 1040NR

I. Taxpayer Identification Number

J. When to File

1. General Rules

2. Extensions of Time

K. Where to File

L. Filing Through an Agent

M. Additional Forms That May Need to Be Attached to Form 1040NR

N. Dual-Status Aliens

1. Dual-Status Tax Return

2. Prorating Income for the Year

O. Estimated Tax Requirements

P. Civil Penalties for Late Filing or for Underpayment of Tax

1. Late Filing Penalties

2. Accuracy-Related Penalty

3. Other Penalties Related to Underpayments

4. Statutory Interest

5. Penalty for Failure to Disclose Treaty Return Position

Q. Form 1040NR-EZ

R. Enforcement and Collection

1. General Rules

2. IRS Access to Foreign Information

3. Collection of Tax Judgments in Foreign Countries

S. Erroneous Filing of Form 1040 Instead of Form 1040NR

IX. Special Categories of Aliens

A. Introduction

B. Alien Partners in Partnerships That Are ETBUS

C. Entertainers and Athletes

D. Students, Trainees and Teachers

1. Students

a. Scholarships and Awards

b. Business Expense Deduction

c. Compensation for Part-Time Work

d. Election to Be a Resident Alien

2. Trainees

3. Teachers

E. Employees of Foreign Governments and International Organizations

F. Directors Attending U.S. Board Meetings

G. Aliens Involved with International Shipping and Aircraft

1. Crew Members of Foreign Vessels and Aircraft

2. Aliens Who Operate an Unincorporated Shipping or Aircraft Business

H. Beneficiaries of Non-Grantor Trusts

1. Beneficiaries of Domestic Trusts

2. Beneficiaries of Foreign Trusts

I. Aliens from Community Property Countries

J. Former U.S. Citizens and Resident Aliens

1. Former Citizens and Long-Term Green Card Holders under § § 877 and 877A

2. Special § 7701(b)(10) Rule

K. Aliens Resident in U.S. Possessions

L. Nonresident Alien Gamblers

M. Illegal Aliens

N. Incarcerated Aliens

X. Deferred Compensation and Pensions

A. Introduction

B. IRS Rules on Sourcing of International Compensation

1. General Rules

2. Single-Year vs. Multi-Year Arrangements

C. Deferred Compensation Plans

1. Voluntary Salary Deferral Arrangement

2. Incentive Plans

D. Distributions from a Tax-Qualified Retirement Plan

1. General Principles

2. Taxation of Non-Treaty Aliens

3. Taxation of Treaty Country Aliens

E. Payments from an Unfunded "Top-Up" Retirement Plan

1. General Principles

2. Taxation of Non-Treaty Aliens

3. Taxation of Treaty Country Aliens

F. Equity-based Compensation

1. Exercise of Rights under a U.S. Stock Option Plan

2. Restricted Stock Plans

XI. Tax Clearance for Departing Aliens

A. General Requirements

B. Exceptions to the Procedures

C. Procedures Applicable to Nonresident Aliens

1. Nonresident Alien with No Taxable Income

2. Nonresident Alien with Taxable Income Whose Taxable Period Is Not Terminated

a. Form 1040-C

b. Employer Letter of Guarantee

3. Nonresident Alien Whose Taxable Year Is Terminated


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Section 7701(b)(4) Election To Be Treated As U.S. Resident

Worksheet 2 Tax Reform Act of 1984, Excerpts from Joint Committee Explanation of Code Section 7701(b)

Worksheet 3 IRS Publication 519, Tax Guide for Aliens

Worksheet 4 Visa Symbols for Classifying Nonimmigrant Aliens

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Committee Reports:

IRS Notices:

IRS Procedures and Rulings:

Cases:

UNOFFICIAL

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