NONRESIDENT ALIENS TAX COMPLIANCE Presentation to U NIVERSITY OF N ORTH C AROLINA C ONTROLLERS W...

NONRESIDENT ALIENS TAX COMPLIANCEPresentation to

UNIVERSITY OF NORTH CAROLINA CONTROLLERS WORKSHOP

May 7, 2012

Presented by:

Cordella H. Scott

KPMG Senior Manager

International Executive Services

Tax Practice

[email protected]

(404) 222-7615

Donald E. Rich, Jr.

KPMG

Tax Partner

Exempt Organizations

[email protected]

(336) 433-7071

© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 35755WDC

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ANY TAX ADVICE IN THS COMMUNCATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPSED ON ANY TAXPAYER OR (ii) PROMOTING,

MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.


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THE MATERIAL CONTAINED IN THESE COURSE MATERIALS IS CURRENT AS OF THE DATE PRODUCED. THE MATERIALS HAVE NOT BEEN AND WILL NOT

BE UPDATED TO INCORPORATE ANY TECHNICAL CHANGES TO THE CONTENT OR T0 REFLECT ANY MODIFICATIONS TO A TAX SERVICE

OFFERED SINCE THE PRODUCTION DATE. YOU ARE RESPONSIBLE FOR VERIFYING WHETHER OR NOT THERE HAVE BEEN ANY TECHNICAL

CHANGES SINCE THE PRODUCTION DATE AND WHETHER OR NOT THE FIRM STILL APPROVES ANY TAX SERVICES OFFERED FOR PRESENTATION TO CLIENTS. YOU SHOULD CONSULT WITH WASHINGTON NATIONAL TAX

AND RISK MANAGEMENT-TAX AS PART OF YOUR DUE DILIGENCE.


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Learning Objectives

Define nonresident aliens for US tax purposes

Identify the general rules of nonresident alien withholding

Identify a withholding obligation for employers of nonresident

aliens

Identify individuals subject to nonresident withholding

Differentiate between required documentation of foreign status

Understand application of treaty articles to nonresidents

Identify reporting obligations

Share best practices


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Nonresident Aliens

Nonresident alien for US tax purposes are individuals who are not a US-Citizen and who do not meet the green card test or the substantial presence test.

Foreign Nationals work in the US under various types of visas.

Individuals and employees are not always sure how the these individuals should be taxed.

Often certain types of visas have special tax benefits on FIT, FICA and FUTA


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Overview of nonresident alien withholding and reporting rules and regulations

There are special federal income tax withholding and reporting rules for nonresident aliens, which are governed by Internal Revenue Code section 1441.

Failure to comply with these rules may lead to under-withholding and

reporting of federal income tax on wage and non-qualified

scholarship payments made to nonresident aliens.

These rules are complex and require tax specialists familiar with the

U.S. tax law.

Assistance may be provided by software, tax research services,

tax professionals, and IRS publications and forms.


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The Law

Section 1441 of the internal Revenue Code states that a withholding agent is required to withhold federal income tax from all income payments made to or on behalf of a nonresident alien.

Treasury Regulations Sec. 1.1461-2 requires that all such payments be reported to the IRS.

Section 1461 holds withholding agents liable for uncollected taxes, plus penalties and interest.


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What is the general rule of NRA withholding?

§ 1441(a) 30% income tax withholding rate on income of any NRA derived from sources

within the United States Exception to 30% withholding rate for payments made as salaries, wages,

remuneration or other personal services income provided such compensation is otherwise subject to withholding under § 3402 or 3401(a) Treas. Reg. § 1.1441-4(b)

14% withholding rate on certain types of scholarships


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Who is required to withhold tax?

Any person, U.S. or foreign, that has the control, receipt, custody, disposal, or payment of an item of income of a foreign person subject to withholding. Foreign intermediary Foreign partnership U.S. branch

When several persons qualify as a withholding agent with respect to a single payment only one tax is required to be withheld and deposited.


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Who is required to withhold tax?

NRA withholding applies only to payments made to a payee that is a foreign person

Foreign person includes nonresident alien individuals or an individual who is not a citizen or national of the United States

An individual who makes an election under § 6013(g) or (h) is treated as a resident for federal income tax purposes and for purposes of wage withholding under Chapter 24 of the Code (§ 3401, et seq.) for payments of wages made during the tax year to which the election relates


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Identifying the nonresident alien population

It is relatively simple to identify a U.S. Citizen or Permanent Resident Alien; however, there is only one method that can be used to identify a Resident Alien or a Nonresident Alien for tax purposes –

The Substantial Presence Test


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The substantial presence test is comprised of two parts:

the 31 day test

the 183 day test


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The 31-Day Test

An alien will satisfy the substantial presence test if he is physically present in the US for at least 31 days during the current calendar year and 183 days during the three year period that includes the current and two years preceding the current year as shown on the following slide.


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The 183 day component of the substantial presence test is a calculation of:

All the days present in the U.S. during the calendar year

+ 1/3 of the days present in the U.S. in the 1st preceding year

+ 1/6 of the days present in the U.S. in the 2nd preceding year.

= TOTAL DAYS FOR TAX PURPOSES


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Exempt Individuals

Foreign government-related individuals and diplomats (generally “A” or “G” visas) – no time limit

F, J, M or Q students and dependents (for 5 calendar years in a lifetime)

J or Q non-students and dependents (for 2 of the past 6 calendar years)

Professional athletes (generally “P” visas)


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Non-Exempt Individuals

Among other visa categories, the following visa types are not exempt from counting days toward the Substantial Presence Test:

H-1BTNL-1R-1


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The term “exempt individual: refers ONLY to the calculation of the substantial presence test; it does not refer to an individual who is exempt from paying federal or FICA tax or from filing a U.S. income tax return


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When determining the U.S residency of J visa holders, you must identify the individuals’ primary purpose for being present in the U.S. You can find this information on the supporting documentation for the individuals’ visa – Form DS 2019


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Residency change and start date

For individual who meets the substantial presence test during the calendar year, the residency start date should be the first day during such calendar year on which the individual is present in the United States (Internal Revenue Section 7701(b)(2)(A)(iii).

However, 10 days of de minimis presence may be ignored for the purpose of determining the residency start date, but not for the substantial presence test. If the individual has more than 10 days of presence in the U.S. such

presence may not be ignored for the purpose of determining the residency start date (i.e., all of the days count).


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Nonresident tax compliance

Determining U.S. taxable income for nonresident aliens, including scholarships, fellowships and compensation.


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What types of payments are considered “income”?

Compensation (wages/salary to employees) Scholarships/Fellowships Room/Board Stipends Book Allowances Prizes and Awards Honoraria/Guest Speaker Fees Compensation for Independent Personal Services Travel Reimbursement Royalties Dividends Interest


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Determining Taxable Income

Remember the GENERAL RULE – ALL INCOME paid to a nonresident alien or to a third party on his or her behalf is TAXABLE unless otherwise excluded.

The only three ways to “exclude” income: Foreign Sourced Income Internal Revenue Code Income Tax Treaty


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Compensation Sourcing

Location of Activity

U.S. Source Income

Foreign Source Income

U.S. Source Income


U.S. Outside U.S.

U.S

.O

utsi

de U

.S.

Loca

tion

of P

ayor

Compensation is sourced at the location where

the activity is performed.



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Scholarship/Fellowship Sourcing

Location of Activity



Outside U.S.

Out

side

U.S

.U

.S.

U.S.

Scholarships/ fellowships are sourced at the location of the

true payer, with one

important exception.

Loca

tion

of P

ayor


Scholarships/ fellowships are sourced at the location of the

true payer, with one

important exception.

U.S. Source Income


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Scholarships and Fellowship Grants

Income is sourced based on these components:

The resident of the payor of the grant, in combination with, the location of the educational activity (e.g. study or independent research)

To be considered US sourced both the payor and the educational activity must be US sourced

If the true payor is located outside the US the grant is foreign sourced and exempt from US taxation

Likewise is the educational activity takes place outside the US the grant is foreign sourced and exempt from US tax.


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Foreign Sourced Income

Treasury Regulation 1.863-1(d)(2)(ii) provides that foreign sourced income includes scholarships, fellowship grants, grants, prizes and awards made by a foreign government (or an instrumentality, agency or any political subdivision thereof), an international organization, or a person other than a U.S. person. An example is the World Health Organization.

Revenue Ruling 89-67 provides that if a true agency relationship exists between the international organization and the intermediary who disburses the grant, the grant will be treated as having been made by the international organization and not the disbursing agent.


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Internal Revenue Code Exclusions

Several exclusions from income exist under the Internal Revenue Code: Section 117 (qualified scholarship) Section 102 (gift) - rare Section 872(b)(3) (foreign employee) – exclusion for compensation paid

by a foreign employer to a nonresident alien temporary present in the U.S. under an F, J, M or Q visa.

Section 861(a)(30) – exclusion for compensation paid $3,000 or less by a foreign employer for services performed for 90 days or less, compensation is not considered U.S. sourced and therefore not subject to U.S. tax.

Section 893 (foreign government/international organization employee) Section 125 (“cafeteria plan”) Accountable Plan Rules (Section 61 and 274) – only applies to

employees and independent contractors.


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Section 117 Exclusion

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The “Qualified Scholarship” Component

QUALIFIED (Non-Taxable)

• Tuition• Required

enrollment/atten-dance fees

• Required books, supplies and equipment

NONQUALIFIED (Taxable)

• Stipend• Room/Housing• Board/Meals• Travel• Cash paid to

individual recipient• Non-required

equipment• Etc.

The “Qualified Scholarship” Component

QUALIFIED (Non-Taxable)

• Tuition• Required enrollment/

attendance fees• Required books,

supplies and equipment

NONQUALIFIED (Taxable)

• Stipend• Room/Housing• Board/Meals• Travel• Cash paid to

individual recipient• Non-required

equipment• Etc.


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Section 117 Exclusion

Section 117(c) stipulates that qualified scholarships do not include any amount received which represents payment for teaching, research or other services by the student required as a condition for receiving the scholarship.

Section 117(d)(1) and (2) stipulates that gross income shall not include any qualified tuition reduction provided an employee of an educational institution for undergraduate education for the employee or any person treated as an employee under section 132(h).

Section 117(d)(5) extends the benefits of Section 117(d)(1) and (2) to teaching and research assistants.


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Income Tax Treaties

An income tax treaty serves to reduce or eliminate double taxation. In theory, a nonresident alien who works in the U.S. must pay taxes in both the U.S. and his or her home country on the one stream of income. A tax treaty enables the individual to, in effect, pay the tax at one time to one country.

Almost all income tax treaties have articles dealing with some combination of students, trainees, teachers and researchers. However, all may not provide benefits in each category.


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Qualification for Exemption under an income tax treaty

Qualification for an Income Tax Treaty Exemption Presumes the Following:

Residency status of the individualThe individual must be a resident of the country with whom the U.S. has a

treaty in force

• Citizen is not the same as residency

• Individual may have residency card from home country

• Verification of residency in home country may be documented on I-20 or DS-2019


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Qualification for exemption under an income tax treaty


Residency status of the individualMay need to look to home country laws or residency article of treaty

(including tie-breaker rules) to determine residency status for questionable cases.

• If not sure of individual’s status as resident of home country – don’t allow treaty exemption


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Residency status of the individualThe individual must be a nonresident of the U.S. unless there is an

exception to the “Savings Clause” which permits residents, or in some cases, permanent residents, to avail themselves of the treaty benefits.


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Residency status of the individualType of payment made

• The income tax treaty article may contain an exemption for compensation only, as is the case for most Teacher/Researcher Article or

• The treaty article may contain an exemption for scholarship/fellowship grant, compensation for services and remittances or allowances from abroad as is often the case with student articles

• Review the income tax treaty and make sure that the type of payment being made is covered.


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Income Tax Treaty Exemptions

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Teacher/Researcher

Articles Generally: • 2 year exemption period• Time limits are expressed in

calendar years• Applies to compensation• No dollar limits• May restrict the payer to an .

educational or research institution

Student Articles Generally:

• 5 calendar year or specific period of study exemption period

• Time limits are expressed in 12 month consecutive time periods

• Applies to non-service fellowships/scholarships and compensation

• $2,000 to $5,000 per year limit on compensation

• No dollar limit on non-service fellowship/scholarship

• Few restrictions on payer

Teacher/Researcher

Articles Generally: • 2 year exemption period• Time limits are expressed in

calendar years• Applies to compensation• No dollar limits• May restrict the payer to an .

educational or research institution

Student Articles Generally:

• 5 calendar year or specific period of study exemption period

• Time limits are expressed in 12 month consecutive time periods

• Applies to non-service fellowships/scholarships and compensation

• $2,000 to $5,000 per year limit on compensation

• No dollar limit on non-service fellowship/scholarship

• Few restrictions on payer


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Qualifications for Exemption under an income tax treaty

Time Limits – General Rules Regarding Teacher/Researcher ArticlesNormally the exemption for teaching or research is available for a period

not to exceed two years from the date of arrival in the U.S.

Measured from the date of the individual’s last entry into the U.S. prior to the teaching/research assignment

Brief absences do not cause period to stop and restart – e.g. Christmas vacation

Exception is the People’s Republic of China teacher/researcher article• 3 year time limit measured in days.


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Specific Requirements of Certain Income Tax Treaties

“From Abroad” Clause

The “From Abroad” Clause – Student/trainee articles may contain a clause which exempts payments from abroad for the student’s/trainee’s education, training and maintenance

These offer no real value as non-service scholarships/fellowships are sourced to the location of the payer, which if foreign, makes the payment foreign sourced income. Foreign sourced scholarships and fellowships are not taxable to nonresident aliens.


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Once in a lifetime Clause Many income tax treaties only permit the use of the tax treaty

exemption one time during the individual’s lifetime. Example: Portugal (Article 22, Teacher Researcher and France (Article 20, Teacher/Researcher)


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Retroactive Clause Dollar Limits – Canadian income tax treaty

• The dependent personal services article uncharacteristically provides benefits for employees of U.S. educational institutions

• No time limit with regard to exemption unless employed by the foreign employer

• Exemption applies with regard to U.S. employer, however, if more than $10,000 is earned in any one year, the exemption is lost retroactively.

Time Limits – several teacher/researcher articles may eliminate the exemption retroactively should the time limitations be exceeded

• Examples: United Kingdom, the Netherlands and India


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Back-to-Back Clause/Combination Clause Tax treaties may prevent individual from claiming an exemption

immediately following the claim of exemption under another treaty article or the use of the same treaty article for multiple occasions. Article 20 of the U.S. German income tax treaty contains a prohibition on use of teacher/researcher exemption immediately following exemption for students/business apprentices.

Not-for-Profit ClauseIn order to claim exemption, research must be undertaken in the public

interest and not primarily for the benefit of specific person(s).


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Research Institution Provisions Generally teachers and researchers may not claim exemption unless

the payment is made to them by an educational institution, which maintains a regular faculty, curriculum, has an organized student body and has education as its primary purpose

Exemptions for which benefits are extended to those performing services for research institutions include:• China, U.S.S.R and Venezuela


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Documentation

Form W-9—identifies a payee as a U.S. person—no withholding requirement from a withholding agent

W-8BEN or Form 8233—established the payee as a non-U.S. person—withholding required (in the case of personal services income or certain scholarship/grant amounts) W-8BEN can also be used to claim a reduced rate of, or exempt from,

withholding as a resident of a foreign country (that has a treaty with the U.S.)

Form W-8ECI—used by a foreign person to exempt effectively connected income from withholding. To be used instead of W-8BEN for effectively connected income


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Documentation

Form 8233 is used for dependent (employee) and independent (non-employee) compensation

Nonresident alien students, trainees and teachers are also required to provide additional information in statements as prescribed in the IRS Revenue Procedures

Within 5 days of receipt, the withholding agent is required to review Form 8233, complete Part 11 of the Form and forward it, including attachments to the IRS.

The exemption is effective 10 days from submission to the IRS, although the exemption is retroactive to the date the form was filed. Thus if the withholding agent is confident that the exemption is valid, he may rely on the exemption concurrent with filing with the IRS.


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Documentation

Form W-8BEN is used for all non-compensation exemptions, including scholarship, fellowship, and royalty payments

Unless scholarship exemption claimed on Form 8233 Must include valid TIN The form is valid until the individual’s facts and circumstances change Withholding agent must review form, but does not have to sign Does not have to be submitted to the IRS


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No Documentation

If no documentation exists, the withholding agent must withhold using certain presumption rules Classify the payee as an individual, corporation, partnership,

etc. U.S. or Foreign?

If payee is presumed to be a U.S. person, then potentially subject to backup withholding (28%)

An agent that follows the presumption rules will not be liable for withholding tax or for related penalties and interest even if it is established later that the withholding was incorrect


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Compensation for personal service

30% withholding rate, unless the pay is specifically exempted from withholding or subject to graduated withholding

Compensation for personal services performed by a NRA is exempt from withholding if the compensation is effectively connected with a U.S. trade or

business; if the compensation is subject to wage withholding at source at

graduated rates pursuant to § 3402; or if the compensation is exempt from income tax under any provision

of the Code or under a tax treatyFor pay for personal services to qualify as wages, there must be

an employer-employee relationship


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Dependent Personal Services Treaty Article

Salaries, wages and other similar remuneration derived by the performance of services as an employee

Generally, employment compensation earned in the United States by a foreign national will be taxable in the United States unless all of the following conditions are satisfied: The foreign national is a resident of a foreign country and not the

United States under the applicable treaty The individual is present in the United States for not more than

183 days during the applicable period (a taxable year, calendar year, or any 12-month period, as defined by the applicable treaty)

The remuneration is paid by, or on behalf of, an employer who is not a resident of the United States, and

The remuneration is not borne by a permanent establishment that the foreign employer has in the United States


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Independent Personal Services Treaty Article

Income from services performed by a self-employed individual, (rather than an employee)

Compensation for independent personal services performed by a foreign national in the United States is generally exempt from U.S. income taxation if the foreign national does not maintain a fixed place of business in the United States (includes, contract labor and professional services) Note that directors are not “employees” for purposes of

applying § 3402. Therefore, the IPS article may also apply to them in addition to self-employed individuals (assuming there is no directors’ fees article in the relevant treaty)


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Tax Withholding Responsibilities

Compensation paid to nonresident alien employee is subject to special graduated withholding rates. Form W-4 must be completed in the following manner:

Single (Regardless of actual marital status)

One withholding allowance (regardless of number of dependents, exceptions for Canada, Mexico, Northern Mariana Islands, American Samoa, Korea, India)

Withholding must be adjusted to account for the absence of standard deduction for nonresident aliens

Internal Revenue Bulletin 2005-76


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Tax Withholding Responsibilities

All income payments made to a nonresident alien or to a third party on his or her behalf are either:

Exempt:

Foreign Source

Internal Revenue Code

Income Tax Treaty

OR

Taxable:

Graduated Withholding (employee compensation)

14% - (Scholarships/Fellowships to F,J,M and Q visa holders)

30% - (Non-employee compensation and all other payments)


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Withholding Requirements

For taxable income payments, the standard nonresident alien rate of withholding tax is 30%; however, there are several exemptions:

Income excluded as foreign source, under Internal Revenue Code or income tax treaty.

Reduced rate (14%) for scholarships/fellowship payments to F, J, M and Q visa holders.

Per Diem payments under USAID Contracts – no withholding unless exceeds per diem.

Compensation – graduated withholding.


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Reporting

Form 1042 is used by a withholding agent to report the annual aggregate of payments of U.S. source income subject to NRA withholding

Due March 15 of the following year in which the compensation was paid

Must show the aggregate amount of income paid and tax withheld that was required to be reported on all the Forms 1042-S for the preceding year

Form 1042-S is used to report U.S. source income to nonresidents

Used to report all employee compensation payments that are exempt from taxation under an income tax treaty

And

All other income paid to a nonresident alien regardless of whether the payment is taxable

Form 8809, 30-day extension of time to file form 1042-S


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Year End Reporting

Employees who receive wages entirely subject to graduated tax withholding should receive Form W-2

Employees who receive wages entirely exempt under an income tax treaty should receive a Form 1042-S

Employees who receive wages partially exempt under an income tax treaty should receive Form 1042-S and Form W-2.


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Qualified Scholarships

1461 Regulations

Qualified scholarships are not required to be reported on Form 1042-S beginning January 1, 2001

However, taxable scholarships still require reporting on Form 1042-S for nonresident aliens.


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FICA Tax Withholding

To be exempt from FICA tax withholding under section 3121(b)(19), an individual must meet all of the following three criteria:

Nonresident alien for tax purposes

F, J, M, and Q visa holders, and

Performing services in accordance with the primary purpose of the visa’s issuance (i.e., the primary holder of the visa – the “1” visa holder)


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B-1 and B-2 Payments

Educational institutions may pay honoraria to B visa holder if for a “usual academic activity or activities”:

Lasting no more than 9 days at a single institution

For services conducted for the benefit of that institution, and

Only if the visitor has not accepted such payments from more than 5 institutions in the previous 6 months.


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Other Discussion Topics

May institutions pay nonresident aliens travel costs (e.g. airline) directly to third party thus “removing” it from the nonresident’s income?

Is withholding agent required to pay withholding tax even if tax cannot actually be withheld from the payment?

What are the withholding requirements for independent contractors (visiting for speeches, conference chairs and other short term activities)?

Are there withholding requirements on travel reimbursement payments made to foreign nationals?

Cordella H. ScottKPMG Senior Manager

International Executive [email protected]

(404) 222-7615

and

Donald E. Rich, Jr.KPMG Partner, Tax

[email protected](336) 443-7071

Questions and Answers?

Thank you!


The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

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