20 Oct Tax Issues for Resident and Nonresident Aliens
The U.S. attracts foreign investment and entrepreneurs by providing various incentives in the tax code for starting and expanding American businesses. It can also contain traps, however, for the poorly advised. The following is a brief overview of the U.S. tax laws as they apply to foreign investors and entrepreneurs.
The first thing that non-citizens need to be aware of is whether they are residents or non-residents for tax purposes. The key difference is that U.S. residents are taxed on their worldwide income while nonresidents are taxed by the U.S. only on the portion of their income that is earned from a U.S. source.
Here, nationality is not determinative. Instead, there are two ways to determine a foreign person’s tax residency: (1) the green card test; and (2) the substantial presence test.
Green Card and Substantial Presence Tests
According to the first test, a green card holder is automatically considered a U.S. resident for tax purposes. Under the second test, to be considered a tax resident, the alien must be physically present in the U.S for at least 31 days in a calendar year and at least 183 days over three consecutive years.
For example, an alien who was physically present in the U.S. 31 days in 2017, three months in 2016, and three months in 2015, would meet the requirements of the substantial presence test because presence consists of 31 days in 2017 and at least 183 days over three years.
It should be noted that individuals should not count the days they are in the United States for less than 24 hours or days that they are in transit between two places outside the United States.
However, even if a foreign person meets the substantial test requirements, she can be treated as a nonresident alien if she demonstrates a closer connection to a foreign country. Generally, individuals have a closer connection to a foreign country in which they have a tax home. A tax home is the place where an individual works as an employee or as a self-employed individual. The individual’s permanent address, the location of her family members, and the location of certain social activities may also be taken into account by the IRS in order to establish a closer connection to a foreign country than the United States.
For nonresident aliens, it is important to figure out the source of their different types of income. For salaries, wages, and other compensation, the source of income is where the services were performed. Interest payments and dividends, however, are sourced according to the residence of the payor. For dividends, the residence of the payor depends on whether the corporation is incorporated in the U.S. or if it is a foreign corporation.
For resident aliens, the tax rates are the same graduated rates that apply to U.S. citizens. However nonresident aliens’ incomes are also subject to graduated rates when the income is effectively connected with a trade or business in the United States. This also means that they are eligible to take all of the deductions that are related to the trade or business in the U.S.
If a nonresident alien has no income related to a trade or business in the U.S., then a flat 30% rate applies. In such a case, no deductions are allowed.
A resident alien can claim tax credits for income taxes paid to a foreign country. An alien who is not a resident can also claim these tax credits if he receives foreign-source income that is taxable because it is effectively connected with a trade or business in the U.S.
Treaties between the U.S. and other countries can provide for a lower tax rate for a nonresident alien’s income. For example, many treaties provide that dividends from sources in the U.S. are subject to tax at a treaty rate not to exceed 15%. A treaty can also provide for an income tax exemption.
Restricted Stock Issues
If a nonresident alien owns shares of restricted stock in a U.S. company and is expected to move to the U.S while the shares are vesting, it is recommended that such person file a “protective” 83(b) election. This election pertains to section 83(b) of the Internal Revenue Code and allows a person to treat the issuance of restricted stock as compensation at the time of grant instead of at the time of vesting. If the person does not make the election and then becomes a resident for tax purposes, the shares will be taxed as ordinary income at the time of vesting rather than as capital gains which are taxed at lower rates. Moreover, the capital gains tax can be deferred until the stock is sold by the taxpayer if the section 83(b) election is made.
Social Security Numbers (SSNs)
Noncitizens who want to work in the United States need a social security number. However, they must be authorized to work in the United States before applying for a social security number. Documents that alien applicants for a SSN should provide to the Social Security Office include a foreign passport, a work permit (or similar document), a U.S immigration document (e.g., a permanent residence card, if any), and a Form I-94. It is recommended to apply 10 days after arriving in the United States so that it is easier for the Social Security Administration to verify the information given. The process is usually fast. It takes between 7-15 days to receive the social security card.
Individual Taxpayer Identification Numbers (ITINs)
An ITIN is a tax processing number issued by the Internal Revenue Service. The IRS issues ITINs to foreign nationals and others who have federal tax reporting or filing requirements but do not qualify for SSNs. A non-resident alien individual not eligible for an SSN who is required to file a U.S. tax return only to claim a refund of tax under the provisions of a U.S. tax treaty needs an ITIN.
As Congress takes up tax reform, it is important to remember that the formation and expansion of American businesses is vital to the continued economic growth of our country and can be facilitated by future tax policy. Currently, immigrants and nonresident taxpayers face significant transactional and administrative challenges under the U.S. tax laws. Accordingly, the GOP tax plan aims to simplify and streamline the rules in order to increase the efficiency of local business transactions.