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By Thomas S. Bissell, CPA
Although the international provisions of the "Camp proposals" for U.S. tax reform primarily affect "outbound" corporate investors, several affect individuals and could have a substantial cross-border impact. This commentary discusses one of those – the proposed repeal of the Federal Insurance Contributions Act ("FICA") exemption for foreign students and exchange visitors.1 It is this author's belief that while it may well be time to re-examine the FICA exemption for many of these individuals, any consideration of repealing the exemption should be done as part of a much broader review not only of the other federal tax rules that affect them, but perhaps of other non-tax federal programs that affect them as well.
The FICA exemption for foreign students (most of whom hold "F" visas) and exchange visitors (most of whom hold "J" visas) was originally enacted as part of the Mutual Educational and Cultural Exchange Act of 1961 (the so-called "Fulbright-Hays Act").2 The exemption was one of a number of provisions that liberalized the taxation of income realized by F- and J-visa holders. Other provisions of the Fulbright-Hays Act included an exemption from the federal unemployment tax ("FUTA"); a reduction in the withholding tax rate under §1441 from 30% to 18% (later reduced to 14%) on taxable scholarships; and, very importantly, an income tax exclusion under §872(b)(3) for salary paid to an F- and J-visa employee of a foreign employer (even if the individual is paid by a U.S. branch of the foreign employer).
The committee reports to the Fulbright-Hays Act make clear that having to pay the FICA tax had become an irritant to F- and J-visa holders, in view of the fact that few of them expected ever to accrue the minimum 40 "quarters" of coverage to qualify for U.S. social security retirement benefits. In 1961 the maximum employee FICA tax annually was $144 (based on an employee FICA tax rate of 3% and a maximum annual "wage base" of $4,800). The FICA tax now consists of two components: the old age (retirement), survivors, and disability insurance ("OASDI") tax and the Medicare tax. The OASDI tax is imposed on the employee's wages at the rate of 6.2%.3 However, the maximum amount of wages taken into account for this purpose is adjusted annually and currently is at $118,500 for 2015.4 The Medicare tax is imposed on the employee's wages at the rate of 1.45%.5 In addition, with respect to taxable years beginning after December 31, 2012, an employee is subject to additional tax at the rate of .9% of the amount by which wages exceed $250,000 in the case of a joint return, and generally $200,000 in all other cases.6 There is no limit on the amount of wages taken into account for purposes of the Medicare tax. Because the OASDI wage base has exploded since 1961 and Medicare tax has been added, the potential effect of repealing the FICA exemption for F- and J-visa holders is much greater now than it was in 1961, even considering the impact of inflation. The Camp proposal estimates that this proposed repeal (together with the repeal of a FICA exemption for foreign agricultural workers) would raise $7.7 billion over 10 years.7
Although the OASDI wage base has increased dramatically since 1961, very few foreign students earn anywhere near the threshold amount annually during the years that they are pursuing their studies – although some of them might earn substantial salaries during the one year of U.S.-situs "practical training" that is permitted to many of them after they finish their studies. Similarly, most J-visa holders do not earn substantial salaries, but, because most of them work in some kind of regular employment (often as a supplement to uncompensated training), the proposed FICA exemption repeal could affect them more harshly. Based on the Department of Homeland Security statistics, the number of F-1 visas that has been issued has increased steadily from 385,000 in 2010 to 596,000 in 2014, and the number of J-1 visas has increased from 33,000 in 2010 to 42,000 in 2014. Although the statistics do not show how many of the F-1 visa holders do any work (whether part-time or full-time) as employees, there are undoubtedly a large number who work at least part-time in permissible employment.
Although the effect of repealing the FICA exemption could be costly for large numbers of F- and J-visa holders, the principal reason for enacting the exemption in 1961 – that very few of the F- or J-visa holders would ever accumulate the required 40 quarters of coverage in order to qualify for U.S. social security retirement benefits – no longer exists for numerous aliens who work temporarily in the United States. Since the 1970s, the United States has entered into social security "totalization" agreements with 25 foreign countries, most of them "developed" industrialized countries. Under these agreements, if an individual accrues at least six quarters of U.S. social security coverage, he or she may qualify for a "totalized" U.S. social security benefit upon retirement.8 In order to accrue one quarter of coverage, an individual must earn $1,220 in covered employment (for 2015), and if he or she earns at least $4,880 in 2015, the individual would accrue four quarters of coverage. If a foreign student worked part-time and earned $4,880 in 2014 and at least $2,440 in 2015, therefore, the required six quarters of coverage would be earned. Because most J-visa holders earn much more than do foreign students during their stay in the United States, so long as the J-visa holder's U.S. stay straddles two calendar years, in most cases six quarters of coverage would be accrued. In addition, if the F- or J-visa holder could arrange to be paid by a foreign employer, in many cases it would be possible to avoid FICA under the taxing provisions of the relevant totalization agreement, even if no FICA exemption were available under the Code itself.
However, for those F- and J-visa holders from developing countries that do not have a totalization agreement with the United States – including all of Africa, Asia (except for Australia, Japan, and South Korea), and Latin America (except for Chile) – the proposed repeal of the FICA exemption in most cases would be an added cost that would never be recouped. In the interest of fairness, therefore, one possibility might be to repeal the FICA exemption but only for F- and J-visa holders from totalization countries. Although a FICA provision of this kind has never been enacted, and administering a selective repeal of this kind could be enormously complex, one must be sympathetic to an important underlying theme in the Camp proposals, i.e., that as many "revenue-raisers" as possible need to be found in order to pay for the broad reductions in individual and corporate taxes that are being proposed.
At the same time, Congress needs to be mindful of the sensitivity behind all of the tax provisions that were enacted in 1961 for the benefit of F- and J-visa holders. Although the 1961 committee reports include a good deal of now-dated language about the importance of being fair to these aliens in order to improve the image of the United States vis-a`-vis the Communist Bloc, an important national priority today should still be to treat all foreign students and exchange visitors as fairly as possible from the standpoint of federal taxation. Many of these individuals who return home permanently often become enormously influential both within government and outside of government in their home countries. And even though many F- and J-visa holders stay permanently in the United States and do eventually accrue 40 quarters of social security coverage,9 exactly who will stay and who will not can rarely be predicted before the individual's F- or J-visa expires.
If repeal of the FICA exemption for F- and J-visa holders is to be seriously debated, therefore, the debate should take place in the broader context not only of federal tax policy but also of other federal laws and programs that affect these individuals. The Camp proposals do not mention any of the other tax rules that were enacted in 1961 for their benefit. It may well be time to re-examine some or all of those rules as well – but only in this broader context.
This commentary also will appear in the July 2015 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Bissell, 6830 T.M., International Aspects of U.S. Social Security and Unemployment Taxes, and in Tax Practice Series, see ¶5440, Employment Tax Withholding Requirements.
Copyright©2015 by The Bureau of National Affairs, Inc.
1 The proposal is contained in section 1503 of the draft Tax Reform Act of 2014, the text of which was released by then-Chairman Dave Camp of the House Ways and Means Committee on February 26, 2014. The Ways and Means Committee's announcement of the proposals is at http://waysandmeans.house.gov/news/documentsingle.aspx?DocumentID=370987, which contains links to the text of the bill and to a section-by-section summary of the bill. (The bill was introduced as H.R. 1 on Dec. 10, 2014.) Another proposal in the bill that would have a substantial impact on cross-border individuals is the proposed repeal (contained in section 1412) of the §217 moving expense deduction for individuals who make a job-related move, whether entirely within the United States, from the United States to a foreign country, or from a foreign country to the United States. Neither the FICA proposal nor the moving expense proposal is included in the Obama Administration's 2016 Budget. Unless otherwise stated, all "§" references are to the Internal Revenue Code, as amended, and the regulations promulgated thereunder.
2 See section 110(e) of Pub. L. No. 87-256, which enacted §3121(19) (FICA exemption for nonresident aliens holding F- and J-visas). This exemption was later extended to include "M" visas for vocational training programs and "Q" visas for certain cultural exchange programs, after the immigration rules were expanded to create those particular visas. The Camp proposal would also repeal the FICA exemption for M- and Q-visa holders. Because only a few thousand aliens hold M- or Q-visas in any year, this commentary discusses only F- and J-visa holders. The committee reports explaining this and other tax provisions of the Fulbright Act are contained in 1961-1 C.B. at pages 395 ff. See http://www.google.com/search?q=%22P.L.+87-256%22+%22Committee+Reports%22&hl=en&gbv=2&oq=&gs_l.
7 The Camp proposal's revenue estimate does not break down the $7.7 billion estimate between students and exchange visitors on the one hand, and foreign agricultural workers on the other. The proposed repeal of the FICA exemption for qualifying foreign agricultural workers is not discussed in this commentary.
9 As a general rule, a J-visa holder is required to leave the United States for a minimum period of time upon the expiration of his or her visa. However, many of these individuals eventually return to the United States on different nonimmigrant visas, or as permanent residents.
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