Tax Returns for Foreign Nationals

by Paula N. Singer, Esq. 

U.S. taxpayers generally must submit a Form 1040 tax return (or the simpler Form 1040A or 1040EZ) and their state tax return by April 15th. (Some states have later deadlines.) Foreign nationals may also have a U.S. tax return obligation, but their tax return may not be Form 1040. Their tax return and due date depends on their federal tax-residency status - resident alien, nonresident alien, or dual-status alien - and the type of income they received. Foreign nationals may also have state tax return obligations as well.

A. Resident Aliens
Foreign nationals who are immigrants (i.e., “green card holders”) or who are substantially present under the 183-day residency formula are resident aliens. Resident aliens for the full calendar year may submit Form 1040 using the same rules as U.S. citizens. As with U.S. citizens, resident aliens are subject to U.S. income tax on their worldwide income. Resident aliens may have tax return considerations that are different than most U.S. citizens, however.

1. Income
Resident aliens may have income from sources outside the United States that they must record on their Form 1040. Income from abroad is taxable even if the income was not reported on an information return and was never sent to them in the United States. For example, resident aliens with foreign bank and/or investment accounts must record the interest, dividends, and capital gains from these accounts on Form 1040. Resident aliens can avoid double taxation on their income from abroad using foreign tax credits (Form 1116).

If their account funds exceed the equivalent of $10,000 in the aggregate, resident aliens must disclose the accounts on Form TD 90.22-1 (called an “FBAR”). They may also have to disclose gifts and inheritances from abroad on Form 3520. (Such gifts and inheritances are not subject to income taxes, however.) Resident aliens who are owners of foreign entities may have disclosure obligations as well.

Resident aliens with rental income abroad must record the income and expenses on Schedule E with depreciation computed using the special 40-year straight line depreciation for property predominantly outside the United States. Capital gains on sales of property denominated in a foreign currency are computed using the exchange rate as of the date of acquisition for the cost basis and as of the date of the sale for the proceeds.

Resident aliens with taxable scholarship or fellowship grants record the amount on the line for “wages, salaries, tips, etc.,” indicating “SCH” on the dotted line. Resident aliens with treaty-exempt grants or personal services income follow instructions in IRS Publication 519, U.S. Tax Guide for Aliens, for such claims.

Immigrants working abroad may use Section 911 foreign-earned income exclusions and/or foreign tax credits to avoid double taxation. Only immigrants who are nationals of a tax treaty country may use the Section 911 bona-fide-residence test. Immigrants who claim nonresidency status under a treaty tiebreaker rule (Form 8833 required) may jeopardize their future U.S. immigration benefits. Special reporting rules described in IRS Publication 519 also apply to certain long-term residents who lost their immigrant status through abandonment or termination. (Form 8854 required in the year of loss.)

2. Deductions and Credits
Generally, resident aliens may claim personal exemptions for their dependents. They may not, however, claim personal exemptions for their dependents who are not U.S. citizens, resident aliens, or U.S. nationals. An exception applies for nonresident alien dependents who are citizens of Canada or Mexico who were tax resident of the home country for part of the year.  For an exemption claim, dependents must have a U.S. taxpayer identification number i.e., a social security number (SSN) or individual taxpayer identification number (ITIN).

Resident aliens may claim tax credits using the same rules as U.S. citizens. For example, if eligible, they may claim child and dependent care credits, education credits, child tax credits, and earned income credit (EITC). To claim the EITC, however, the taxpayer, spouse, and qualifying child(ren) must each have an SSN, an unlikely situation for most nonimmigrants since only the authorized worker may obtain an SSN.

B. Nonresident Aliens
Nonresident aliens file a Form 1040NR tax return, not Form 1040. Nonresidents may be claiming that status under a closer connection exception (Form 8840 or 8843 required) or tax treaty tiebreaker rule (Form 8833 required).

Nonresidents are taxed on two types of U.S.-source income:

• Fixed or determinable annual or periodic (FDAP) income such as dividends, interest, gains, rents, and royalties (recorded on page 4) and
• Income effectively connected to a U.S. trade or business (called ECI) which includes personal services income and taxable scholarship and fellowship grants - recipients in F, J, M, or Q status only (recorded on page 1)

Nonresidents with ECI are required to file a tax return even if all of their income is treaty-exempt. Nonresidents whose only U.S.-source income is wages not in excess of the personal exemption amount ($3,400 for 2007, $3,500 for 2008) are not required to file a return, however. Nonresidents who are exempt from counting days (certain individuals in F, J, M, or Q status) must submit a Form 8843 with their tax return or separately if they have no tax return obligation.

Nonresidents with only FDAP income are not required to submit a tax return if the tax (30% or a lower treaty rate) was properly withheld by the payer. Nonresidents who are physically present in the U.S. for 183 days or more (whether countable or not) may not claim exemption from tax on U.S.-source capital gains on sales of personal property such as securities. Capital loss carryovers from prior years are not allowed. Nonresidents with proceeds from sales of U.S. real estate are required to file a return even though 10%  may have been withheld on the proceeds. Interest from accounts with U.S. banks, savings and loans, or insurance companies is exempt from tax, even if reported on Form 1099.

1. Filing Status and Deductions
Nonresidents may only use single or married-filing-separately status. Married nonresidents may not elect to file using married-filing-jointly status. Only one personal exemption is allowed with a few exceptions for residents of Canada, Mexico, and South Korea, and U.S. nationals.

Nonresidents may not claim the standard deduction. They may claim limited itemized deductions such as state income taxes, charitable contributions to U.S. charities (and charities in Canada, Mexico, and Israel as allowed by treaty), business deductions, and casualty losses. They may not claim mortgage interest or real estate tax deductions. Although nonresidents with ECI may claim tax credits, the credits allowed are very limited (described in Form 1040NR instructions). No education credits are allowed even if a nonresident received Form 1098-T. (This form relates only to education credits and does not report income.)

Special tax treaty rules apply to residents from India who came to the U.S. as students or business apprentices. They may claim the standard deduction and may claim a personal exemption for their spouse and for dependents who are U.S. citizens or resident aliens.

2. Filing Rules and Dates
Eligible nonresidents may use the simpler Form 1040NR-EZ, which was designed for foreign students and scholars. Form 1040NR-EZ generally applies to nonresidents whose only income is from wages or taxable grants and who do not claim dependents. All other nonresidents with a filing obligation such as recipients of honorarium payments must use Form 1040NR. Nonresidents with treaty-exempt income not reported on Form 1042-S under Exemption Code 04 must include an attachment with information that they otherwise would have been required to provide the payer (such as all information required on Form W-8BEN or Form 8233).

Nonresidents who received wages subject to wage withholding must file by April 15th. Otherwise, Form 1040NR and 1040NR-EZ (and Form 8833, 8840 or 8843 if no return is required) are due on June 15th (16th in 2008).

Nonresidents who require an ITIN for themselves and/or dependents must submit the return with all applicable Forms W-7 (ITIN applications) with required certified documentation with the IRS at the address in the Form W-7 instructions. All other Form 1040NR and 1040NR-EZ tax returns and forms must be filed with the Internal Revenue Service Center, Austin, TX 73301-0215.   

C. Dual-Status Aliens
Foreign nationals may have a dual-status return obligation in the year in which they become resident aliens or in their year of departure from the United States. Dual-status aliens who become resident aliens for any part of the subsequent tax year must file as full year resident aliens for both the current and subsequent calendar year.

1. Income and Expenses
Income received and expenses paid while a resident alien are taxed under the rules for resident aliens. Income received and expenses paid while a nonresident alien are taxed under the rules for nonresident aliens. The tax return depends on the taxpayer’s status on December 31st, resident alien (Form 1040) or nonresident alien (Form 1040NR). Income and expenses from the respective nonresidency or residency period may be explained on an attached “Dual-status Statement.” The attachment must include the taxpayer’s name, address, and SSN or ITIN.

Income and expenses explained in the statement are recorded on the appropriate lines of the return, Form 1040 or Form 1040NR. “Dual-status Return” must be recorded at the top of the respective return. Taxes on FDAP income in the nonresidency period must be computed on Form 1040NR. For Form 1040 the tax is recorded on line 63 with “Total from Form 1040NR” on the dotted line. ECI such as wages is added to wages in the residency period and taxed at graduated rates.

2. Special Limitations
Special limitations apply to dual-status aliens:

• They may not claim the standard deduction (except students and business apprentices from India may use the standard deduction up to the amount of ECI during the nonresidency period)
• They may not use head of household status and rates
• They may not use married-filing-jointly rates
• They may not use personal exemptions in the residency period to reduce income below zero

IRS Publication 519 includes sample dual-status returns. Dual-status returns are filed with the Internal Revenue Service Center, Austin, TX 73301-0215. The filing date is April 15th for a dual-status Form 1040 return. Filing dates for dual-status Form 1040NR returns are as described above for Form 1040NR.  

D. State Tax Returns
States impose income taxes differently on state residents and state nonresidents. The terms “resident” and “nonresident” for state income tax purposes are determined by the state imposing the taxes. (Generally, the same rules apply to determine the state tax residency status as for U.S. citizens.) Most state tax authorities post their residency rules on their website.

States tax their residents on worldwide income and their nonresidents on state-source income as defined by the state. If a foreign national is a nonresident alien for federal purposes and the state defines income with reference to the Code, only the U.S.-source income included for federal income tax purposes is taxed by the state. Such states allow tax exemption for treaty-exempt income as well unless the state requires that treaty-exempt income be added back into income (Connecticut, for example).

For more information concerning tax returns for foreign nationals, read Paula N. Singer, Esq.’s tax guide International Aspects of Individual U.S. Tax Returns.

Paula Singer, Esq., Co-founder and Chairman of Windstar Technologies, Inc. and partner in the tax law firm, Vacovec, Mayotte & Singer LLP, Newton, MA, has over 25 years of experience providing advice and compliance services to individuals and their employers, and payers on cross-border matters.

Watch for Volume 5, Number 2 for "FICA Exceptions for J-1 Exchange Visitors."

Q: Do I have to pay U.S. capital gains tax on sales of my assets?

A: It depends.

If you are a resident alien, you are subject to U.S. income taxes on worldwide income, including your capital gains on sales of assets located abroad.

If you are a nonresident alien, the tax on your gains depends on your number of U.S. days of physical presence in the calendar year (regardless of whether the days were exempt from counting). If you do not have 183 U.S. days, you are not subject to U.S. income taxes on U.S.-source gains. If you do have 183 U.S. days or more (typically nonresidents in A, G, F, J, M, or Q status), your net gains are subject to 30% tax. You cannot use capital losses from prior years to offset these gains. This exception does not apply to the sale of a U.S. real property interest which is subject to U.S. tax.

The source of income from gains on personal property (tangible or intangible) is based on the location of your tax home. Generally, your tax home has changed to the United States if your stay is anticipated to be for more than one year. If your tax home has changed to the United States, gains on your worldwide assets are treated as U.S.-source gains. There is an exception if your were a student who came to the United States to study and you have no effectively connected income (such as personal services income or taxable grants) during your U.S. stay. In that case, your tax home did not change to the United States and all of your gains are foreign-source.

One caution:  If you are a nonresident alien and you have contingent gains from use of a patent, the payments are considered royalties and are subject to 30% tax if attributable to use of the patent in the United States. Contingent gains from use of a patent are accorded long-term capital gain treatment under Code section 1235 for resident aliens (and citizens).

Register Today for Windstar’s Spring Nonresident Alien Tax Training

Registration is now open for Windstar’s Spring Nonresident Alien Tax Training being held April 22 – 25, 2008 at the Embassy Suites Boston – Logan Airport. Windstar’s nationally recognized experts will teach you the latest information in nonresident alien taxation and immigration issues. In addition, all attendees will receive hands-on training on International Tax Navigator®.

Don’t miss your opportunity to learn what’s new and what’s important in nonresident alien taxation and immigration. Register today for Windstar’s Spring Nonresident Alien Tax Training!

Paula N. Singer Esq.’s “The 10 Rules of U.S. Taxation of Payments to Foreign Nationals” Featured in Tax Notes International

Tax Notes International, the weekly publication from Tax Analyst, featured Paula N. Singer, Esq.’s article on “The 10 Rules of U.S. Taxation of Payments to Foreign Nationals” in their January 7, 2008 edition. Please e-mail editor@windstar.com for a copy of the article. 

Paula N. Singer, Esq. to Participate in IRS Webinar on International Tax Issues

Paula N. Singer, Esq. will serve as a panelist for the Internal Revenue Service’s "International Tax Issues: Understanding Tax Treaties" webinar being held on Tuesday, March 11th from 2:00 – 3:00 pm Eastern time.  For more information visit http://taxtalktoday.tv/.

Windstar Will Dock at These Upcoming Trade Shows

The Higher Education Users Group (HEUG) Alliance 2008
MGM Grand Hotel
Las Vegas, NV
March 10th - 13th, 2008
Booth Number: 528

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Society for Human Resource Management (SHRM) Global Forum
Back Bay Exhibition & Conference Center – Boston Copley Place
Boston, MA
March 30 – April 2, 2008
Booth Number: 427

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For the latest in trade show information, check in future issues of Crow's Nest or visit http://www.windstar.com/public/events.html.

©Copyright 2008 by Windstar Technologies, Inc. Windstar reserves all rights to this electronic material. Information contained in this publication is based on the best information available at the time of publication.  While believing the information in this publication to be accurate, Windstar accepts no legal responsibility for its accuracy.

Since 1995 educational institutions, hospitals, research institutions, and corporations have relied on Windstar Technologies, Inc. to deliver the expertise to comply with the U.S. tax residency rules, tax rates, and special tax exemption rules under the law and U.S. treaties.  When government agencies require information about foreign nationals in the workplace, Windstar provides straightforward analysis and reporting.  Comprehensive software for analysis and reporting, expert knowledge, and unparalleled customer service combine to make Windstar the first choice for nonresident alien tax compliance.

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