Under the U.S. tax code, the immigration law categories of “immigrant”, “nonimmigrant” or “illegal alien” do not apply. Instead, for federal income and employment tax purposes the important distinction is whether the foreign national is a “resident” or “nonresident” alien, or in some cases, both, in any one year. There are certain exceptions to the general tax rules.
Resident or Nonresident Alien
In general, an individual is a nonresident alien unless he or she meets the qualifications under either residency test:
- Green card test: The individual is a lawful permanent resident of the U.S. at any time during the current year, or
- Substantial presence test: The individual is present in the U.S. for at least 31 days during the current year and at least 183 days during the current year and the previous two years. For computing the 183 days, a formula is used that counts all the qualifying days in the current year, 1/3 of the qualifying days in the immediate preceding year, and 1/6 of the qualifying days in the second preceding year.
In several situations, an individual may be classified as a nonresident alien even though he/she meets the substantial presence test. For example, an individual will be treated as a nonresident alien if he/she has a closer connection to a foreign country than to the United States, maintains a tax home in the foreign country, and is in the United States for fewer than 183 days during the year. Another example is that an individual in the United States under an F-, J-, M- or Q-visa may be treated as a nonresident alien if he/she has substantially complied with visa requirements. Other individuals that may be treated as nonresident aliens even if they meet the substantial presence test include employees of foreign governments and international organizations, regular commuters from Canada or Mexico, individuals who are unable to leave the United States because of a medical condition, foreign vessel crew members, aliens in transit through the United States, and athletes participating in charitable sporting events.
The residency rules in an income tax treaty override the U.S. rules.
Taxation of Income
- Resident Aliens: As a general rule, resident aliens for tax purposes are subject to the same federal income tax laws as citizens of the U.S.
- Nonresident Aliens: Nonresident aliens are taxed on income from sources within the U.S. but generally not on income from foreign sources.
A nonresident alien’s U.S. source income is taxed at different rates depending on whether it is “effectively connected” with a trade or business in the U.S. “Effectively connected” income is income received while engaging in a trade or business in the U.S. It includes compensation for the performance of personal services in the U.S. Nonresident aliens with F-, J-, M-, and Q- visas are considered to be engaged in a trade or business in the U.S.
Income that is effectively connected with a trade or business in the U.S. is generally taxed by the same rules and at the same graduated rates as the income of U.S. citizens and resident aliens. Income that is not effectively connected may not be reduced by most deductions and is generally taxed at a flat rate of 30%. Nonresident aliens file a return using the Form 1040NR series and are subject to the same collection procedures as U.S. citizens and resident aliens. Additionally, nonresident aliens are generally subject to withholding requirements on personal services compensation and non-effectively connected income.
There are limited circumstances in which a nonresident alien’s U.S. source income is not subject to U.S. taxation. Furthermore, income may be exempt from U.S. tax under a treaty.
Tax treaties provide benefits to nonresident aliens and, in certain situations, resident aliens. Benefits vary by treaty and typical provisions include the reduction of the 30% flat rate applied to non-effectively connected U.S. source income and the exemption of gain from the sale of personal property. Treaties often exempt personal service compensation from taxation if a nonresident individual is in the Unites States for less than a stated period of time (e.g. 90, 180, or 183 days) or the compensation is less than a specified amount (generally between $3000 and $10,000) and paid by a foreign employer. Additionally, the compensation of specific groups of employees (e.g. students, teachers, athletes, and employees of foreign governments) is often exempted from U.S. tax.
The United States has tax treaties with the following countries: (updated 04/23/13)
Armenia, Australia, Austria, Azerbaijan, Bangladesh, Barbados, Belarus, Belgium, Bulgaria, Canada, China, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Georgia, Germany, Greece, Hungary, Iceland, India, Indonesia, Ireland, Israel, Italy, Jamaica, Japan, Kazakhstan, Korea, Kirghyzstan, Latvia, Lithuania, Luxembourg, Malta, Mexico, Moldova, Morocco, the Netherlands, New Zealand, Norway, Pakistan, Philippines, Poland, Portugal, Romania, Russia, Slovak Republic, Slovenia, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Tajikistan, Thailand, Trinidad and Tobago, Tunisia, Turkey, Turkmenistan, Ukraine, the United Kingdom, Uzbekistan and Venezuela.
Social Security and Medicare Taxes
- Resident Aliens: Resident aliens are generally subject to Social Security and Medicare taxes on wages (FICA taxes) and on self-employment income (SECA taxes) in the same manner as U.S. citizens. There is, however, a list of exempted services that is generally applicable to all who work in the U.S.
- Nonresident Aliens: Nonresident aliens are generally subject to FICA taxes on compensation from work within the U.S. under the rules applicable to U.S. citizens and resident aliens. There is, however, a list of exempted services that is generally applicable to all who work in the U.S. A non-resident alien with a F-, J-, M- or Q- visa is not subject to FICA taxes on income from the performance of services that meets the purpose of admittance. Nonresident aliens are not subject to taxes on self-employment income.
- Totalization Agreements: The U.S. has entered into totalization agreements with numerous countries that have social security programs.
Finally, an income tax treaty may provide an exemption form Social Security and Medicare taxes. This is unusual, but an example is the treaty with the former Soviet Union that is now applicable to several former Soviet states. For a more detailed discussion of the tax treatment of foreign nationals, please review the Internal Revenue webpage here.