International Aspects of U.S. Income Tax Withholding on Wages and Service Fees (Portfolio 6820)

Tax Management Portfolio, International Aspects of U.S. Income Tax Withholding on Wages and Service Fees, No. 6820, analyzes the U.S. wage withholding rules (for income tax purposes) that apply to aliens working in the United States, and to U.S. citizens and certain aliens working in foreign countries. 

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Description

Tax Management Portfolio, International Aspects of U.S. Income Tax Withholding on Wages and Service Fees, No. 6820, analyzes the U.S. wage withholding rules (for income tax purposes) that apply to aliens working in the United States, and to U.S. citizens and certain aliens working in foreign countries. Also discussed are the rules regarding the 30% U.S. withholding tax on U.S.-source service fees paid to self-employed nonresident alien individuals, and U.S. information reporting requirements concerning wages and service fees paid to employees and self-employed individuals in an international context.

In general, wage withholding is not imposed on remuneration paid to an employee for services performed outside the United States if the employee is a nonresident alien, but withholding tax may apply (subject to numerous special rules) if the employee is a resident alien or a U.S. citizen.

Of increasing importance is the question of wage withholding on fringe benefits, and on bonuses and deferred compensation paid to international employees either while they are still working for their employer, or after their termination from service. Numerous special withholding rules are applied which attempt to match the amount of withholding tax with the employee's substantive liability.

In the case of service fees paid to a self-employed individual who is not an employee, withholding is generally required only in the case of fees paid to nonresident aliens with respect to services rendered within the United States. A number of special exceptions may apply, however. In the case of service fees paid to self-employed individuals who are resident aliens or U.S. citizens, withholding is required only in the case of “backup” withholding.

This portfolio may be cited as Bissell, 6820 T.M., International Aspects of U.S. Income Tax Withholding on Wages and Service Fees.

Authors

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 Advisory Board — U.S. International; Member, American Bar Association, American Institute of Certified Public Accountants, Florida Institute of CPAs (FICPA), and member of the FICPA International Taxation Committee; 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
A. General
B. Scope of this Portfolio
C. Status as a U.S. Citizen, Resident Alien, or Nonresident Alien
1. Status as a U.S. Citizen
2. Status as a Resident Alien or a Nonresident Alien
a. Overview
b. General Definitional Rules
D. Nonimmigrant Visa Categories
1. Specific Categories
2. Resident Alien Status of Nonimmigrant Aliens
a. A-Visas (Employees of Foreign Governments, etc.)
b. B-Visas (Business Visitors and Tourists)
c. C-Visas (Transit Aliens)
d. D-Visas (Crew Members of Ships and Aircraft)
e. E-, I-, L-, O-, P-, and TN-Visas (General Working Visas)
f. Students Holding F-, J-, M-, or Q-Visas
g. G-Visas (Employees of International Organizations, etc.)
h. H-Visas (Temporary Workers and Trainees)
i. Teachers, Trainees, and Other Nonstudents Holding J- or Q-Visas
j. R-Visas (Religious Workers)
k. Non-Visa Categories
l. Resident Aliens Reclassified as Nonresident Aliens Under an Income Tax Treaty
m. Illegal Aliens
II. U.S. Income Tax Withholding and Reporting on Employees — General Structure
A. General Statutory Requirements
B. Definition of “Wages”
1. Statutory Exceptions
2. Administrative Exceptions
3. “Worldwide” Embrace of §3401(a)
C. Withholding Tax Rates and Procedures
1. General
2. Percentage Method and Wage Bracket Method
3. Shorthand Features of the IRS Methods
4. Avoidance of Overwithholding; Form W-4
5. Employee Who Expects No Tax Liability
6. Included/Excluded Wages
7. Withholding on Supplemental Wages
8. Timing Problems Resulting in Overwithholding and Underwithholding
a. Overwithholding — Full-Year Employees
b. Underwithholding — Full-Year Employees
9. Additional Withholding
10. Part-Year Employment
11. IRS Publications for Employers and Employees
D. Estimated Tax Requirements of Individuals
E. Crediting of Wage Withholding Tax and Estimated Tax by the Individual
F. Penalties for Underwithholding of §3402 Tax
G. Issuance of W-2 Reporting at Year-End
H. Importance of the Sarbanes-Oxley Legislation
I. Wage Withholding on Behalf of “Disregarded Entities”
J. Employer Appointment of Authorized Agent (Form 2678)
K. Overview of U.S. Income Tax Withholding and Reporting on International Wages
1. “Territoriality” of Wage Withholding Tax
a. General Comments
b. U.S. “Sourcing” Rules
c. Definition of “United States”
2. U.S. Citizens
3. Resident Aliens
4. Nonresident Aliens
L. Foreign Employer with No U.S. Contacts
1. Exposure to Tax
2. Disbursing Agent Subject to U.S. Jurisdiction
III. U.S. Income Tax Withholding and Reporting on Self-Employed Individuals — General Structure
A. Relevant Issues for the Payor of Service Fees
1. Is the Individual an Employee or Self-Employed?
2. Payee's Status as a U.S. Citizen, Resident Alien, or Nonresident Alien
3. Where Are the Services Performed?
4. Is the Payor Engaged in a Trade or Business?
5. Is the Payor a U.S. Person or a Foreign Person?
6. Distinction Between §1441 and §3406 Withholding
B. Backup Withholding Rules of §3406
1. Background of §§6041 and 6041A
a. General Rules
b. All Service Fees Potentially Covered
c. Payor Must Be Engaged in a Trade or Business
d. Payments Must Total $600 or More
e. Payee Must Be an Individual
f. Treatment of Employees
g. Exception for Certain Nonresident Aliens
h. Global Scope of §§6041 and 6041A
2. “Reportable Payments” Under §3406
C. Nonresident Alien Withholding Under §1441
D. FATCA Rules Under §§1471–1474
E. Overview of U.S. Income Tax Withholding and Reporting on International Service Fees
1. U.S. Citizens and Resident Aliens Working in the United States
2. Nonresident Aliens Working in the United States
3. U.S. Citizens and Resident Aliens Working Outside the United States
4. Nonresident Aliens Working Outside the United States
IV. U.S. Citizens and Resident Aliens Working in the United States as Employees
A. Application of the Territorial Rule
1. Services Performed in the United States
2. Business Trips Outside the United States
B. Treaty-Exempt Wages of a Resident Alien
V. Nonresident Aliens Working in the United States as Employees
A. Territorial Rule Applicable to Nonresident Aliens
B. Services Performed in the United States — Exempt Remuneration
1. Short-Term Business Visitors
2. F-, J-, and Q-Visa Holders
3. Employees of Foreign Governments and International Organizations
a. Direct Employees
b. Employees of Corporations Owned by Foreign Governments
4. Canadian and Mexican Residents
5. Crew Members of Foreign Vessels
6. Remuneration Exempt Under an Income Tax Treaty
C. Services Performed in the United States — Taxable Remuneration
1. Special Form W-4 Rules for Nonresident Alien Employees
2. Withholding on U.S.-Source Remuneration Only if Classified as Wages
3. Services Performed Both Within and Without the United States
4. Wage Withholding Is Almost Never at 30% Rate
D. Nonresident Aliens Electing Resident Status Under §6013(g) and (h)
E. Resident Alien Election Under §7701(b)(4)
F. Estimated Tax Requirements
G. Foreign Employer Who Fails to Withhold
H. Nonresident Aliens Without a U.S. Social Security Number
I. Exceptions from §1441 Withholding
1. Wages Subject to §3402 Withholding
2. Remuneration Exempt from §3402 Withholding
3. Certain Wages Exempt from Withholding Under §3402(e)
4. Form 1042/1042S Filing Requirements
VI. U.S. Citizens and Resident Aliens Working Outside the United States As Employees
A. U.S. Citizens
1. Income Excluded Under §911
2. Remuneration from Working in Certain U.S. Possessions
3. Income Excluded Under §933
4. Remuneration Subject to Foreign Wage Withholding Tax
a. Employer Must Be Legally Required to Withhold Under Foreign Law
b. Foreign Political Subdivisions
c. Rate of Foreign Withholding Tax Not Relevant
d. The Foreign Withholding Tax Must Be on “Income”
e. Relationship to the §911 Exclusion
f. Peculiarities of Foreign Law
g. Noncompliance with Foreign Withholding Law
h. Withholding Agreement with Foreign Government
i. Supplemental Wages
5. Adjustment to Reflect Foreign Tax Credits
6. Employee Who Expects No U.S. Tax Liability
7. Business Days in the United States
8. Withholding if No Exemption Applies
a. General
b. U.S. Employer
c. Foreign Employer with Part or Full U.S. Ownership
d. Foreign Employer with No U.S. Contacts
9. Wage Withholding by U.S. Disbursing Agent
10. Estimated Tax Liability
11. Practical Implications
12. Employees of Foreign Governments and International Organizations
B. Resident Aliens
1. Determining Alien's Status As a Resident
2. No Special §3401(a) Exception
3. Remuneration Excluded from Employee's Gross Income
4. Remuneration Subject to Foreign Wage Withholding Tax
5. Form W-4 May Be Used to Reduce U.S. Withholding
6. Employees Classified as Residents of a Treaty Country
7. Business Trips Back to the United States
8. Foreign Employer with No U.S. Contacts
C. IRS Reporting Even if No Wage Withholding
D. Identifying Employees Who Are U.S. Citizens or Resident Aliens
E. Employees of Foreign Disregarded Entities
F. “Common Law Employees” of a U.S. Corporation
G. Mandatory FICA Coverage for Foreign Entities Under §3121(z)
VII. Nonresident Aliens Working Outside the United States as Employees
VIII. Self-Employed U.S. Citizens and Resident Aliens Working in the United States
A. General Rules
B. Resident Aliens from Certain Tax Treaty Countries
C. Foreign Governments and International Organizations
IX. Self-Employed Nonresident Aliens Working in the United States
A. Self-Employed Nonresident Aliens and U.S. Citizens Compared
B. General Rules
1. U.S.-Source Income Only
2. Withholding Even if Income Is Effectively Connected
3. Identity of Payor and Place of Payment
4. Payor's Knowledge of the §1441 Withholding Requirements
5. Return-on-Capital Income Versus Services Income
6. Self-Employed Status Is Not Elective
C. Procedures Where No Withholding Exemption Applies
1. General Comments
2. Section 1441 Procedures Where No Exemption Applies
3. Prorated Personal Exemption
4. Form 1042/1042S Filing
D. Exceptions from §1441 Withholding
1. Compensation of Certain Canadians and Mexicans
2. Income Exempt Under the Code or a Treaty
a. Short-Term Business Visitors
b. Crew Members of Foreign Vessels
c. Income from the Operation of Ships and Aircraft
d. Tax Treaty Exemptions
e. IRS Penalties for Failure to Document §1441 Exemptions
3. Certain Payments to Ship Masters
4. Contractors with Foreign Governments and International Organizations
5. Reduction in 30% Withholding Rate
6. Form 1042/1042S Filing Requirements
E. Estimated Tax Rules
F. Social Security Tax
G. Special Categories of Aliens
1. Directors' Fees
2. Artists, Entertainers, and Athletes
3. Fellowships of F-, J-, M-, and Q-Visa Aliens
4. Section 6013(g) and (h) Aliens
H. Non-Applicability of FATCA withholding
I. Service Fees Paid to Foreign Partnerships and Foreign Corporations
1. Withholding Under §§1441 and 1442
2. Potential FATCA Withholding
X. Self-Employed U.S. Citizens and Resident Aliens Working Outside the United States
A. Interplay of §§1441, 6041, 6041A, and 3406
B. Regulations that Apply to Foreign Services
C. Summary of the Reporting Rules for U.S. Citizens and Resident Aliens Working Outside the United States
XI. Self-Employed Nonresident Aliens Working Outside the United States
A. The Applicable Regulations
B. Private Letter Ruling 8034102
XII. Withholding and Reporting on Fringe Benefits
A. Typical Fringe Benefits Provided to International Workers
B. Temporary Living Expenses — “Tax Home” Rules
1. Effect of 1992 Energy Act
2. Expenses Qualifying for the “Tax Home” Deduction
3. Applicable Wage Withholding Rules
4. Per Diem Arrangements
C. Taxability of Other Allowances
1. Housing
2. Home Leave Expenses
3. Tuition Expenses for Dependents' Private Schooling
4. Personal Use of Automobile
5. Telephone
6. Moving Expenses
7. Tax Equalization Payments
8. Low-Interest or Interest-Free Loans
9. Cost of Meals
10. Reimbursement of U.S. Education Expenses of a Nonresident Alien Student
11. Miscellaneous Fringe Benefits
D. Sourcing of Taxable Allowances
E. Potential §6662 Penalty
F. Self-Employed International Workers
1. General Rules
2. Nonresident Alien Payees
3. Reimbursements Made Without an Accountable Plan
XIII. Withholding on Bonuses and Deferred Compensation
A. General
B. Section 409A Rules
C. Nonresident Alien Recipient
1. Payment Is Foreign-Source Income
2. Payment Is U.S.-Source Income
3. Combined U.S.- and Foreign-Source Income
D. U.S. Citizen Recipient
1. Payment Is Foreign-Source Income
a. Section 911 Exclusion
b. No §911 Exclusion
c. Other Wage Withholding Exemptions
2. Payment Is U.S.-Source Income
E. Resident Alien Recipient
1. Payment Is Foreign-Source Income
2. Payment Is U.S.-Source Income
F. Funded Deferred Compensation Plans
1. Distributions from U.S. Qualified Plans
2. Plans Not Qualified Under U.S. Law
3. The Rules of §72(f)(2) and §72(w)
4. Special §911 Rules
G. Equity-Based Compensation Plans (Stock Options, Etc.)
H. Deferred Compensation for Self-Employed Individuals
1. In General
2. Equity-Based Compensation
XIV. Special Computational Problems for Employees
A. General
B. Employee Who Moves Abroad During the Year
C. Employee Who Moves to the United States During the Year
1. Pre-Move Salary Exempt from U.S. Tax
2. Alien Employee Fails Treaty Exemption on Pre-Move Salary
D. Improper Treatment of Particular Remuneration
E. Employee Abroad Who Visits the United States on Business
F. Self-Employed Individuals Compared
XV. Tax Payment and Filing Procedures
A. General
B. Wage Withholding Rules
1. Taxpayer Identification Numbers
2. Deposit of Withheld Taxes
3. Forms
4. Penalties
a. Statutory Interest
b. Late Deposit of Tax
c. Late Filing of Form 941
d. 100% Penalty
e. Other Penalties
C. Section 1441 Withholding on Self-Employed Nonresident Aliens
1. Taxpayer Identification Numbers
2. Deposit of Withheld Taxes
3. Forms
4. Penalties
D. Information Returns Required by §§6041/6041A
1. Taxpayer Identification Numbers
2. Withholding of Tax
3. Forms
4. Penalties

Working Papers

Table of Worksheets
Worksheet 1 IRS Industry Specialization Program Coordinated Issue Papers: Shipping and Air Transportation Industry Coordinated Issue — Federal Income Tax Withholding on Compensation Paid to Non-Resident Alien Crew by a Foreign Transportation Entity, July 24, 1995 [Decoordinated]
Worksheet 2 Visa Symbols for Classifying Nonimmigrant Aliens