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Source of Income and Why It Matters
by Paula N. Singer, Esq.
Payers making payments to foreign nationals have the additional task of determining if the payee is a nonresident alien, in which case special U.S. tax withholding and reporting rules apply.
Payers must also determine the source of the income as defined by the Internal Revenue Code. Source of income is important because nonresident aliens are subject only to U.S. income tax and U.S. withholding and reporting on U.S-source income. Foreign nationals who are resident aliens for federal tax purposes are subject to U.S. income tax on worldwide income (as are U.S. citizens) and to the same U.S. withholding and reporting requirements as U.S. citizens.
Foreign-source income of nonresident aliens (regardless of the type of income) is not subject to U.S. tax, withholding, or reporting.
The source of income depends in large part on the character of the income. Withholding and reporting rules also vary by income type.
1. Compensation for Services
The source of income for any payment for which the recipient is required
to perform services (employment or self-employment) is the location
where the services are performed. Compensation for services performed
in the United States is U.S.-source income with a few exceptions. For
example, compensation for services provided in the United States by
a foreign national in F, J, M, or Q status for a foreign employer is
exempt from tax under Section 872(b)(3) of the Code as long as the
compensation is not transferred to the books of a U.S. organization.
Compensation for services performed abroad by a nonresident alien is foreign-source and not subject to U.S. tax, withholding or reporting. But the compensation could be subject to tax (and withholding and reporting) in the country where the services are performed.
Special payroll rules apply to U.S.-source wages paid to nonresident aliens (described in IRS Publication 15, Circular E, Employer’s Tax Guide). U.S.-source self-employment compensation paid to nonresident aliens is subject to 30 percent withholding (absent a tax treaty exemption) and reporting on Form 1042-S (Income Code 16).
2. Scholarship and Fellowship Grants
The source of income for a scholarship or fellowship grant for which
no services are required is generally the residence of the grantor.
If the grantor is a foreign organization or government, the grant is
foreign-source and not subject to U.S. tax for a nonresident alien
recipient. Foreign-source grants paid by U.S. organizations acting
merely as agents for the foreign grantor keep their foreign-source
character.
Noncompensatory scholarship and fellowship grants made by U.S. grantors are U.S.-source income with one exception. Grants for study or research abroad are deemed to be foreign-source by Treas. Reg. Section 1.863-1(c).
In short, the only time a non-compensatory scholarship or fellowship grant is considered U.S.-source is when both the location of the grantor and the activity being supported are in the U.S. All other combinations result in the grant being foreign-source.
U.S.-source grants paid to, or on behalf of, nonresident alien recipients who are in F, J, M, or Q status who are candidates for a degree at an educational organization are subject to 14 percent withholding if no treaty exemption applies, as are grants made by certain grantors specified by Section 1441(b)(2) of the Code. Taxable grants to recipients in any other immigration category are subject to 30 percent withholding. They generally do not qualify for a treaty exemption because, based on their immigration status, they did not enter the United States for the purpose of study, research, or training.
Taxable grants of nonresident aliens (regardless of the withholding rate) must be reported to the recipient and the IRS on Form 1042-S (Income Code 15).
Taxable grants paid to, or on behalf of, resident aliens (and U.S. citizens) are not subject to withholding, nor are they required to be reported on an information return. However, these grant recipients must report their taxable grants on their Form 1040 if their total income exceeds the income threshold for their filing status. To avoid underpayment penalties, taxpayers can submit estimated tax payments.
3. Prizes and Awards
Prizes and awards paid to nonresident aliens are U.S.-source income if
the grantor is a U.S. resident with one exception. Under Treas. Reg.
Section 1-863-1(c) prizes and awards paid to nonresident aliens are
U.S.-source income if paid by a U.S. resident with one exception.
Achievement awards with respect to past activities conducted outside
the United States are treated as foreign-source income. Achievement
awards are defined by the regulation to include those issued by a
charitable organization as defined by Code Section 501(c)(3) or by
the government (or an instrumentality thereof) for a past activity
undertaken in the public interest and not primarily for the private
financial benefit of a specific person or persons or organization.
Under Treas. Reg. 1.863-1(c), an award for past humanitarian activities
in a foreign country is deemed to be foreign source.
U.S.-source prizes and awards paid to nonresident alien recipients are subject to 30 percent withholding if no treaty exemption is available and must be reported on Form 1042-S under Income Code 50. Prizes and awards paid to resident aliens (and U.S. citizens) are reportable on Form 1099-MISC in box 3 and are subject to 28 percent backup withholding if the recipient fails to provide an SSN or ITIN.
Treaty Exemptions from Tax
Foreign nationals, both nonresident aliens and, in some circumstances,
resident aliens, but not U.S. citizens, could be exempt from tax under
an applicable income tax treaty with their country of tax residence
(not citizenship).
To claim an exemption from tax under a treaty, foreign nationals must meet the conditions of a treaty provision (called an “article”), which provides a specific treaty exemption for the type of income being paid and must provide the appropriate withholding certificate – Form 8233, W-8BEN, or annotated W-9 – prior to payment. To be valid for a treaty claim, the form must include an SSN or ITIN, or, in the case of Form 8233, meet the exceptions for no SSN or ITIN at the time of submitting the form.
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 6, Number 1, for a discussion on "Tax Treaty Exemptions for Scholarship and Fellowship Grants."
Q: A foreign organization gave our organization $50,000 and asked us to disburse it as research fellowships to 10 graduate students of our choosing based on any qualification criteria we like as long as the recipients are from the same country as the donor organization. Since the money is coming from abroad, it is foreign-source, right?
A: Not necessarily. Because your organization is not simply acting as a conduit for the funds but is actually selecting the recipients and defining the circumstances under which the awards will be made, your organization is now the true payer. If the research takes place in the U.S., both the grantor (your organization) and the activity will be U.S.-based, resulting in the fellowships being U.S.-source income. If you require that the research be done outside the U.S., the fellowships would be foreign-source income.
2009 Windstar NRA Tax Training Dates Announced
The Windstar Technologies’ Nonresident Alien Tax Training workshops are returning for a 9th consecutive year! Since 2000, hundreds of individuals have received high quality and comprehensive education on nonresident alien taxation, immigration practices, and the International Tax Navigator®. Don’t miss your opportunity to join this group of educated colleagues.
Dates for the 2009 workshops are:
Spring Nonresident Alien Tax Training
April 28th – May 1st
Summer Nonresident Alien Tax Training
August 4th – 7th
Year-end Nonresident Alien Tax Training
December 8th – 11th
In addition to receiving high quality instruction, all attendees receive:
- Comprehensive binder filled with hundreds of pages of helpful resources and presentation slides
- Breakfasts and lunches, along with morning and afternoon breaks
- Two Windstar Publishing® tax guides
- Continuing education credits (for individuals who apply)
- Certificate of completion
All three sessions will be held at the Doubletree Guest Suites Boston. The Doubletree Guest Suites is an all suite hotel located on the banks of the Charles River, just minutes from downtown Boston and its major attractions. Hotel features include:
- Shuttle service to major tourist destinations in Boston and Cambridge and nearby train stations
- Low cost transportation to and from Logan International Airport
- High-def flat screen televisions in each room
- Skellers Jazz Club
Complete agendas and registration will be available approximately ninety days before each session.
Visit www.windstar.com for more information on Windstar’s Nonresident Alien Tax Training program. Or e-mail Paul.Carpinella@windstar.com to receive notification of registration for each training.
Learn More About Windstar’s Products at Upcoming Web Demonstrations
Windstar Technologies is holding free web demonstrations on the PeopleSoft HRMS Interface, International Tax Navigator®, and SEVIS Navigator™ during the first quarter of 2009. The dates for each event are listed below.
- PeopleSoft HRMS – January 28th
- International Tax Navigator – February 25th
- SEVIS Navigator – March 11th
Each webinar will educate you on how to automate and streamline your nonresident alien tax compliance processes using these powerful software tools. All three demonstrations can be viewed right from the comfort of your office free of charge!
Visit Windstar’s events page in January to learn more.
Paula N. Singer, Esq. Appears on Politically Payroll Radio Program
Paula N. Singer, Esq. was the featured guest on the November 12th episode of KLAV’s Politically Payroll program. During the twenty-minute interview, Paula addressed questions on payroll issues surrounding inbound payments to foreign nationals.
Politically Payroll combines payroll topics along with the political issues that surround them. The program airs on KLAV AM 1230 in Las Vegas, Nevada every Wednesday evening at 7:30 pm Pacific time.
Visit www.vickimlambert.com for an on-demand recording of the interview.
Recently Published Articles By Paula N. Singer, Esq.
Paula
N. Singer, Esq. had two articles published in major publications
in November:
- “Tax Code and Treaty Solutions for Resident Aliens Working Abroad,” Payroll Manager’s Report, Institute of Management and Administration (IOMA), November, 2008.
- “A Common-Sense Solution for Taxing U.S. Citizens and Immigrants Abroad,” Tax Notes International, Tax Analysts, November 17, 2008.
Windstar Will Dock at These Upcoming Trade Shows in 2009
Connecticut Association of Independent Schools
Conference
Rosemary Hall, Choate School
Wallingford, CT
February 18, 2009
* * * * * * * * * * * * *
The Higher Education Users Group (HEUG) Alliance 2009
Anaheim Convention Center
Anaheim, CA
March 22 – 25, 2009
* * * * * * * * * * * * *
Windstar
Technologies’ Spring
Nonresident Alien Tax Training
Doubletree Guest Suites Boston
Boston, MA
April 28 – May 1, 2009
* * * * * * * * * * * * *
American
Payroll Association’s
(APA) 27th Annual Congress
Long Beach Convention Center
Long Beach, CA
May 19 – 23, 2009
* * * * * * * * * * * * *
National Association of College and University Business Officers
(NACUBO) 2009 Annual Meeting
Hynes Convention Center
Boston, MA
June 27 – 30, 2009
* * * * * * * * * * * * *
Windstar
Technologies’ Summer
Nonresident Alien Tax Training
Doubletree Guest Suites Boston
Boston, MA
August 4 – 7, 2009
* * * * * * * * * * * * *
Windstar
Technologies’ Year-end
Nonresident Alien Tax Training
Doubletree Guest Suites Boston
Boston, MA
December 8 – 11, 2009
* * * * * * * * * * * * *
Check in future
issues of Crow’s Nest or visit http://www.windstar.com/public/events.html for
the latest in trade show information and speaking engagements.
©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.