Aliens & Citizens: Foreign and Domestic Tax Issues
What we’ll cover… • Are Non-resident Aliens from Mars? • Where is home for Dual Status Aliens? • How do we tax extraterrestrial income? • Do Space Treaties give us room? • How on earth do aliens file?! • Count-down to blast- off… • There is light at the end of the black hole! • Is my account at First Galaxy Bank really “foreign”?
Why does it matter? • US Citizens & Resident Aliens taxed on worldwide income • Non-resident Aliens taxed only on US- source income NOTE: Illegal (resident) aliens must file US tax returns as though they were US citizens/residents using an ITIN
Non-Resident Alien (NRA) • “Alien” is not a US citizen by birth or naturalization • “Non - resident” does not have Green Card and has not been present in the US for requisite time
Green Card • Issued to permanent residents • Permanent unless administratively revoked or voluntarily (but procedurally) abandoned
Substantial Presence Test (SPT) Must be physically present in US (states but not territories) for… • ≥ 31 days during current tax year AND • ≥ 183 days in most recent 3 -year period: – All days in current year PLUS – 1/3 of days in previous year PLUS – 1/6 of days in year prior to previous EXCEPTION: If individual maintains a foreign tax home and a closer connection to one country
Example of Day Count Taxpayer was physically present in US for 120 days in each year 2008, 2009 & 2010… • 120 days in 2010 plus • 40 days in 2009 (1/3 of 120) plus • 20 days in 2008 (1/6 of 120) Total = 180 Does not meet SPT
Days that are not counted If individual… • regularly commutes to work in the US from Canada or Mexico • is in the US for < 24 hours due to international transit • is a crew member of a foreign vessel • is unable to leave the US due to a medical condition • is an “exempt” individual
Exempt individuals include • Foreign government employees/diplomats if only temporary stay • Teachers on J or Q visas unless > 2 years • Students on F, J, M or Q visas unless > 5 years • Professional athletes competing for charity NOTE: Exempt individuals are subject to the SPT for all periods before and after they hold exempt status
Example of Exempt Status A foreign student with an F-1 Visa arrived in the US on January 1st, 2006… • He is considered an NRA for 2006, 2007, 2008, 2009, and 2010 (his wife — not a student — came with him on an F-2 visa and is also an NRA through 2010) • Both husband and wife will be considered residents in 2011, regardless of their academic status
Dual Status Aliens • Individuals who are residents for one part of the year and non-residents for another • Occurs if individual… – enters US and passes SBT in year of arrival (must enter before July 1 st ) – leaves US after passing SBT in year of departure – lost exempt status during the year
Dual Status Elections (IRC § 6013 ) 1. Back-date residency if: – present in US ≥ 31 consecutive days in previous year AND – meets SPT for current year 2. Treat as resident if: – NRA at year-start and resident alien or citizen at year- end AND – married at year-end to a US citizen or resident alien who agrees to file joint return NOTE: A once-in-a-lifetime election which cannot be made again if remarried
Examples of “Residency” Election • Husband/Wife are NRAs at year-start but Husband becomes resident in June. Couple may elect to be treated as resident aliens. They may file jointly or separately in later years. • Husband is a high-income earner US resident whose wife lives abroad and has no income. Husband can file separately or elect to file jointly. • Wife and Son live permanently in the US. Husband joins them mid-year. They may elect to file jointly or Wife may file separately and claim Head of Household status (since Husband is an NRA).
Tax Treatment of NRA’s Income • Taxed only on US-sourced income • Examples of income not considered US- sourced: – Interest paid by US corp if ≥ 80% of gross income is derived from outside US – Interest if funds are deposited in a foreign branch of US bank – Personal service compensation received for work performed outside US – Gain on sale of personal property if taxpayer’s tax home is outside US
Calculating US-sourced Income NRA is a professional hockey player with a US hockey club who received $98,500 for 242 days of play during the year… • Goalie played 194 days in US • Goalie played 48 days in Canada US-source income = (194 242 days) x $98,500 = $78,963
If US-source, is it effectively connected? • Effectively connected if derived from US trade or business – can be reduced by personal exemptions & itemized deductions and taxed at graduated rates • Not effectively connected cannot be reduced – is subject to a flat tax of 30%, (unless a lower treaty rate applies)
Effectively vs. Not Effectively Effectively Connected Not Effectively (taxed at graduated rates) Connected (taxed at 30% rate) US wages Interest income Partnership income Dividends Business income Capital gains (tax exempt if taxpayer in US < 183 days) Gains on sale of US real estate Rental & royalty income Pension income Social Security benefits (85% includable unless exempt under treaty)
Treatment of Rental Income • NRA is taxed on the gross rental revenue – Not effectively connected – Cannot be reduced by deductions for maintenance and management • NRA may elect to treat the rental income as effectively connected under § 871(d) – Can offset income by allowable rental expenses – Taxed at graduated rates on net income
Tax Treatment of NRA’s Adjustments • May contribute to IRAs & other qualified retirement plans • May claim INcoming moving expenses but not OUTgoing • May deduct student loan interest • May deduct penalties on early withdrawal of savings if interest income is effectively connected
Tax Treatment of NRA’s Deductions • NRA may not claim Standard Deduction • Itemized Deductions must be related to effectively connected income – CAN deduct: State/local & property taxes, charitable contributions, casualty losses, and unreimbursed employee expenses – CANNOT deduct: Medical expenses and mortgage interest NOTE: Dual-status taxpayer also cannot use Standard Deduction but may use all itemized deductions
Tax Treatment of NRA’s Tax Credits Same as Must file MFJ Name of Credit Special Rules US citizen w/ US spouse Adoption Child & Dep. Care Child Tax Dependent must be US citizen or resident Prior Year Min. Tax Earned Income Education Energy Foreign Tax Only on effectively connected income Retirement Savings
NRA Filing Status • S, MFS or QW NOTE: Married NRA may file S if resident of Canada, Mexico, South Korea or if married to US national (resident of American Samoa or Northern Mariana Islands ) AND has not lived with spouse for the last six months of the tax year • MFJ if NRA is married to US citizen/resident & elects § 6013(g) • Cannot file HOH NOTE: Resident spouse may file HOH if married to an NRA who is not treated as a spouse for tax purposes
NRA Personal Exemptions • May claim PE for self • Residents of Canada, Mexico, American Samoa & Northern Mariana Islands may claim PE for spouse without US-sourced income • May claim PE for qualified dependents NOTE: ITIN or SSN required for all exemptions claimed
How many PE can NRA claim? • Example 1: NRA exchange student from Russia lives in US with wife (no income) & 2 kids 1 PE • Example 2: NRA exchange student from India lives in US with wife (no income) & 2 kids 2 PE due to special exception for India • Example 3: NRA student from Canada lives in US - wife (no income) & 2 kids live in Canada 4 PE due to special rule for Canadians & Mexicans
Which form? • NRA must use Form 1040NR • Dual-status must use: – 1040 if immigrant becomes resident by 12/31 – 1040NR if taxpayer forfeits residency by 12/31 NOTE: NRA without wage income can delay filing until June 15 th (can also defer ES # 1 payment until June 15 th but must then pay ½ of total ES liability)
Effect of Tax Treaties • Treaties generally reduce tax liability of NRA (not US citizen/resident) & are often reciprocal • Treaty-based positions must be disclosed on Form 8833 – $1,000 failure to file penalty NOTE: Tax return must be filed even if treaty eliminates all tax liability • Refer to IRS Publication 901 NOTE: Not all states conform to federal tax treatment as per intl. treaties
Example of Treatment under Treaty NRA is a resident of a foreign country that has tax treaty with US. 2010 earnings from US sources include $1,400dividends (on which tax is limited to 15% by treaty) and $24,100 compensation for personal services (on which tax is not limited by treaty)… Personal service compensation $24,100 Less: Personal exemption 3,650 Taxable income $20,450 Tax as per tax table for Single $2,653 Plus: Tax on gross dividends 210 Total Tax Due $2,443
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