Nonresident Taxability and Where or How? Nonresident? Is it Taxed and “If” So, “Where and How” on the Tax Return?

December 30, 2019

by: Marc J. Strohl, CPA, Protax Consulting Services Inc.

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The goal of this article is to provide a comprehensive checklist of information for the foreign national to consider prior to accepting an assignment in the U.S.  This article is not designed to teach you the technical competence required to perform self compliance; however it will certainly arm you with the technical knowledge to determine if your U.S. tax preparer knows all that they should know to provide you with technically competent professional services.

 

If:

All U.S. nonresident aliens are taxable in the U.S., but only on U.S. source income.  Internal Revenue Code (IRC) Sec. 861 governs U.S. sourced income, IRC Sec. 862 governs Non-U.S. sourced income and IRC Sec. 865 governs sourcing rules for personal property sales. 

However, U.S. negotiated income tax treaties, if elected may override the source of specific items taxed, and therefore the applicable income tax treaties always need to be consulted in tandem with domestic U.S. law treatment. 

Additionally, in the case of U.S. persons- citizens and green card holders- the U.S. has conveniently slipped in to most income treaties a provision usually, under Miscellaneous Rules, to enable the U.S. to continue to tax U.S. persons as if the income tax treaty does not exist.  This is typically referred to as a “Savings Clause” or “Limitation on Benefits” clause.

 

Where and How:

Where on the tax return that income is taxed and how it is taxed depends upon whether the income is effectively connected with a U.S. trade or business.  Effectively connected income includes compensation income but excludes passive income which is considered non effectively connected income.  IRC Sec. 871 governs which U.S. sourced income is effectively connected with a U.S. trade or business and which income is non-U.S. effectively connected income.

Effectively connected income is reported on Form 1040NR page 1 and is taxed at U.S. regular graduated tax rates and non effectively connected income is reported on Form 1040NR page 4- Schedule NEC- and is flat taxed at a rate of 30%, or reduced treaty rates. 

However, there is one exception below, in the case of Capital Assets (includes everything you own except business related assets, includes shares held for investment, basically all personal property, but not real property) not effectively connected with a U.S. trade or business.  Under this one instance if a nonresident alien taxpayer is present in the U.S. physically for 183 days or less in the tax year, the gain from the Capital Asset is not Effectively Connected. 

If a nonresident alien taxpayer is present in the U.S. physically for more than 183 days the gain is considered effectively connected with a U.S. trade or business and is US source income for the entire calendar year, on US stocks only.  Regardless of the taxpayers “Tax Home”.

Basically the only instance of the Effectively Connected rules overriding U.S. source rules.  IRC Sec 865 overrides IRC Sec. 871

 

If and Where and How:

We have constructed a table to facilitate these determinations:

Income type:   U.S. source rule: “IF”   If U.S. sourced, effectively connected rule: WHERE and HOW:
Interest income   Received from a U.S. resident payer   Not effectively connected, unless from asset or produced by U.S. trade/ business.  Under 871 interest from U.S. bank deposits not taxable.
Dividend income   Received from a U.S. domestic corporation   Not effectively connected, unless from asset or produced by U.S. trade/ business.
Personal service income- wages, salaries, commissions, fees. Per diem allowances & bonuses   If performed in the U.S.   Performance in the U.S. is considered effectively connected. 
Rent/ Royalties   Property located in the U.S.   Not effectively connected, unless from asset or produced by U.S. trade/ business.  However election on rental income to make effectively connected is available. 
Royalties   For use in the U.S.- patents, copyrights, good will TM, etc..   Not effectively connected, unless from asset or produced by U.S. trade/ business.
Real property sale   Property located in the U.S.   Always effectively connected
Inventory- purchased   Sold in U.S.   Always effectively connected
Sale of personal property:  

Seller’s “tax home”, special exceptions include: depreciable, intangibles, sales through office / fixed place of business

 

Only instance of Effectively Connected rules overriding U.S. source rules.  IRC Sec 865 overrides 871, in that if in US 183 days or more = US source for entire calendar year, on U.S. stock only.  Regardless of Tax Home.

 

Not effectively connected, unless from asset or produced by U.S. trade/ business (see below).  If not effectively connected Capital Asset (includes everything you own except business related assets, includes shares held for investment, basically all personal property) then- 183 day rule- or more, not effectively connected, less then  183 days and tax exempt. 

 

If you only trade stock through a U.S. resident broker you are not engaged in a U.S. trade or business.  Even if you are in the U.S.

 

From asset or produced by U.S. trade/ business- Always effectively connected income, whether or not connection.  Two tests determine if investment income (fixed or determinable- interest, rent royalty, Gains (rare types) or Capital Gains) are effectively connected to business- 1) Asset Use and 2) Business Activities Tests.

Scholarships, grants, prizes and awards   Residence of payer for activities performed in U.S.   Either excluded or see Personal service income above.
Pension income   Portion related to U.S. performed services   See Personal service income above.
Alimony   Paid by a spouse to ex- spouse   Residence of spouse obligated to make payments

 

Marc J. Strohl, CPA is a Principal at Protax Consulting Services Inc.
He may be reached at: Tel: (212) 714-1805, Fax: (212) 714-6654
Email: mstrohl@protaxconsulting.com
Web site: www.protaxconsulting.com

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