U.S. Income Taxation of Foreign Students, Teachers, and Researchers (Portfolio 6440)

Tax Management Portfolio No. 6440, U.S. Income Taxation of Foreign Students, Teachers, and Researchers, analyzes the U.S. income tax laws applicable to nonresident alien students, teachers, and researchers who are living, working, and/or studying in the United States. To view this Portfolio, visit Bloomberg Tax for a free trial. 

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Description

Tax Management Portfolio No. 6440, U.S. Income Taxation of Foreign Students, Teachers, and Researchers, analyzes the U.S. income tax laws applicable to nonresident alien students, teachers, and researchers who are living, working, and/or studying in the United States. Resident alien students, teachers, and researchers qualify for special tax benefits not accorded to other resident aliens, and this Portfolio discusses those benefits as well.

Classification of non-U.S. citizens as either resident aliens or nonresident aliens is made using the green card and substantial presence tests. The substantial presence test depends on the number of days that the alien is physically present in the United States, but the Code exempts certain classes of foreign citizens from having to count days toward this test for a specified period of time. Foreign students, teachers, and researchers generally qualify for this special status for a period of time that varies depending on the individual's visa status.

Nonresident alien students, teachers, and researchers are generally subject to U.S. income tax in the same manner and extent as other nonresident aliens. That is, they are only taxed on their income that is effectively connected with a U.S. trade or business and on certain non-effectively connected, U.S.-source gross income. Nonresident alien students, teachers, and researchers, however, face unique questions not applicable to other nonresident aliens. For example, is the payment of a purported scholarship/fellowship grant really disguised compensation for services rendered? Or, can an individual qualify for a “teacher” exemption under an income tax treaty if, immediately before becoming a teacher, he or she was a “student” who qualified for the “student” exemption under the treaty?

Nonresident aliens are generally subject to Federal Insurance Contributions Act (FICA) tax on wages that they receive while working in the United States. All nonresident aliens, however, including students, teachers, and researchers, are eligible for the nonresident alien FICA tax exemption set forth in §3121(b)(19). In addition, nonresident alien students are eligible for the student FICA tax exemption set forth in §3121(b)(10) in the same manner and extent as U.S. citizen and resident alien students.

The tax withholding and reporting rules applicable to payments made to nonresident alien students, teachers, and researchers follow the general nonresident alien tax withholding and reporting provisions, but with special rules for the person's student, teacher, or researcher status. For example, while the general tax withholding rules impose a 30% withholding tax on certain payments to nonresident aliens, certain nonresident alien students can qualify for a reduced 14% withholding rate on taxable scholarships or fellowship grants.

Finally, certain income tax treaties to which the United States is a party provide for variations to the general rules of the Code. These variations are noted where appropriate.

This Portfolio may be cited as Harding, 6440 T.M., U.S. Income Taxation of Foreign Students, Teachers, and Researchers.

Authors

Bertrand M. Harding, Jr., Esq.

Bertrand M. Harding, Jr., Duke University (1968); J.D., The George Washington University National Law Center (1975); former Tax Law Specialist, Internal Revenue Service Exempt Organizations Division (1972–1975); former attorney-advisor to Judge Bruce M. Forrester, United States Tax Court (1975–1977); former tax partner, Baker & McKenzie, Washington, D.C. office (1984–1996); lecturer on college and university tax matters; author, The Tax Law of Colleges and Universities, 5th ed.

Table of Contents

Detailed Analysis
I. Introduction
II. Classification as a Nonresident Alien
A. General Rules
B. Green Card Test
C. Substantial Presence Test
1. General Rule
2. Closer Connection Exception
3. Computing Days of Presence in the United States
4. Disclosure Statement
5. Illegal Aliens/Asylum Status Aliens
6. Residency Starting and Ending Dates
a. Residency Starting Date
b. Residency Ending Date
7. Election to Treat Spouse as a Resident Alien
D. Coordination of Residency Rules with Income Tax Treaties
III. Income Taxation of Students, Teachers, and Researchers
A. Background
B. Nonresident Alien Students
1. Scholarships and Fellowship Grants
a. Distinguishing Grants from Gifts, Loans, Prizes/Awards, and Compensation
(1) Grant Versus Gift
(2) Grant Versus Loan
(3) Grant Versus Prize/Award
(4) Grant Versus Compensation
b. Source of Grants
c. Taxation of Grants
d. Section 117 Exclusion
(1) The “Qualified Scholarship” Requirement
(2) The “Educational Organization” Requirement
(3) The “Candidate for a Degree” Requirement
e. Income Tax Treaty Exemptions
(1) The Residency Requirement
(2) Classification as Student or Teacher/Researcher
(3) Student Exemption Articles
(4) Student Articles in Russia, Kazakhstan, and Ukraine Income Tax Treaties
2. Compensation for Services Rendered
a. Source of Income
b. General Rule of Taxation
c. Income Tax Treaty Exemptions
3. Savings Income
4. Deductions, Credits, and Rates for Nonresident Alien Students
a. Deductions
b. Tax Credits
c. Rates
C. Nonresident Alien Teachers and Researchers
1. Compensation for Services Rendered
a. In General
b. Exclusion for Certain Exchange or Training Program Participants
c. Exclusion for Foreign Government/International Organization Employees
d. Payments to Foreign Guest Lecturers
e. Income Tax Treaty Exemptions
(1) Residency Requirement
(2) Primary Purpose Requirement
(3) Educational Institution Requirement
(4) Time Period of Exemption
(5) Status as Teacher/Researcher Before Coming to the United States
(6) Compensation Versus Fellowship Grant
(7) Dependent and Independent Personal Services Articles
2. Tuition Waivers
a. General Rule
b. Graduate Tuition Waivers
c. Tuition Waiver Versus Compensation
3. Other Income
4. Deductions, Credits, and Rates for Nonresident Alien Teachers and Researchers
D. Resident Alien Students, Teachers, and Researchers
IV. Social Security Taxation of Nonresident Alien Students, Teachers, and Researchers
Introductory Material
A. The Nonresident Alien FICA Tax Exemption
B. The Student FICA Tax Exemption
C. Impact of Income Tax Treaties
D. Social Security Totalization Agreements
V. Income Tax Withholding on Payments Made to Nonresident Alien Students, Teachers, and Researchers
Introductory Material
A. Basic Concepts
1. “Withholding Agent”
2. U.S.-Source Income
3. “Foreign Person”
4. FDAP Income
5. Classifying the Type of Payment Made
B. Exceptions to Withholding
1. ECI
2. Wage Payments
3. Per Diem Payments Under U.S. AID Contracts
4. Income Exempt Under the Code
5. Income Exempt Under an Income Tax Treaty
a. Form 8233
b. Form W-8BEN
c. Form W-9
d. Form 8833
e. TIN Requirement
C. Amount of Tax to Be Withheld
1. Wages
2. Scholarship/Fellowship Grants
a. General Rules
b. Reduced Withholding Procedures
3. Income Subject to a Special Treaty Rate
D. Special Situations and Problems
1. Social Security/Individual Taxpayer Identification Numbers
2. Situations Where Tax Cannot Be Withheld from the Payment
E. Reporting Requirements for a Withholding Agent
1. Form 1042
2. Form 1042-S
3. Filing Requirements
a. Who Must File
b. Where and When to File
c. Electronic and Magnetic Media Requirements
d. Penalties for Failure to File
F. Reporting Requirements for a Nonresident Alien Student, Teacher, or Researcher
G. Reporting Nonresident Alien Qualified Tuition and Related Expenses on Form 1098-T

Working Papers

Table of Worksheets
Worksheet 1 List of Relevant IRS Forms and Publications
Worksheet 2 List of Relevant IRS Guidance
Worksheet 3 Summary Table of Student Tax Treaty Provisions
Worksheet 4 Summary Table of Teacher/Researcher Tax Treaty Provisions
Worksheet 5 December 16, 1998 IRS Letter to Coopers & Lybrand, LLP Regarding Whether Withholding Agent Is Required to Withhold Tax on Reimbursed Expenses Paid to Nonresident Alien Guest Lecturers
Worksheet 6 Commonly Used Non-Immigrant Visas
Worksheet 7 Visa Program Waiver Countries