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Tax Residency Rules

by Paula Singer, Esq.

Introduction
Where once only major multinational corporations employed foreign workers in the United States, now small and medium-sized businesses, and even individuals, may employ foreign workers. These workers may be in the United States in any number of immigration categories including - H-1B Specialty Worker, L-1 Intra-company Transferee, O-1 Person of Extraordinary Ability, TN Professionals from Canada or Mexico under NAFTA, F-1 Student under Optional Practical Training, J-1 Exchange Visitor, Q-2 Cultural Exchange Participant. U.S. income and employment tax rules vary with the employee's immigration status and substantial presence in the United States.

Federal Income Tax
Under the federal income tax rules, foreign workers who are resident aliens are subject to federal income tax in the same manner as U.S. citizens. U.S. citizens and resident aliens are subject to federal income tax on worldwide income regardless of where the individual resides or works, in the United States or abroad.

Foreign workers who are nonresident aliens are subject to federal income tax under a completely different set of rules. Nonresident aliens are subject to federal income tax on U.S. source income including "income effectively connected to a U.S. trade or business," Such income, called ECI, includes compensation for services performed in the United States. ECI is taxed after deductions at single or married filing separately rates. A nonresident alien cannot claim the standard deduction and, with few exceptions, can claim only one personal exemption.

A resident alien who meets specified income thresholds must submit a Form 1040 or 1040EZ tax return. Generally, a nonresident alien paid by a U.S. employer must submit a Form 1040NR or 1040NR-EZ regardless of the amount of ECI.

Employment Tax Considerations
The federal wage withholding rules mirror the federal income tax rules. For example, in completing Form W-4, Employee's Allowance Certificate, a nonresident alien worker must:

Claim single status, whether single or married,
Claim only one personal exemption with a few exceptions, and
Include an additional withholding amount based on the payroll cycle to compensate for the standard deduction built into the withholding tables (except for students from India)

Neighbors from Canada and Mexico
Nationals from Northern Mariana Islands and American Samoa
Residents from South Korea and Japan (years prior to 2005)
Students from India

In certain situations, a nonresident alien worker may be eligible for exemption from social security and Medicare taxes. IRS Publication 15, Circular E, Employer's Tax Guide describes these special withholding rules.

In order for an employer to apply the appropriate employment tax rules, an employer must know whether a foreign worker is a resident alien or a nonresident alien.

Resident Alien or Nonresident Alien
A foreign worker's residency status, resident or nonresident, depends upon the worker's immigration category and substantial presence in the United States. Generally, a foreign worker who is a U.S. lawful permanent resident (a "green card holder" or immigrant) is a resident alien for income tax purposes. A nonimmigrant, who is substantially present in the United States over a period of years, is also a resident alien.

A nonimmigrant is substantially present if his or her U.S. days (including partial days) over 3 calendar years equals or exceeds 183 days based on a formula. The 183-day formula considers all of the U.S. days in the current calendar year, plus 1/3 of the U.S. days in the prior year, plus 1/6 of the days in the year before the prior year. A nonimmigrant whose U.S. days average less than 122 per calendar year remains a nonresident alien.

A nonimmigrant, whose U.S. days under the formula equals or exceeds 183, is a resident alien unless an exception applies. A nonimmigrant who 1) has fewer than 31 U.S. days in the calendar year, 2) can support a claim of a closer connection to a foreign country than to the United States on IRS Form 8840, or 3) can support a claim of nonresidency status under a residency tie-breaker rule of an applicable income tax treaty is a nonresident alien.

Nonimmigrants in certain categories may remain nonresident aliens for policy reasons. These nonimmigrants, called "exempt individuals," are exempt from counting days for purposes of the 183-day residency formula. Exempt individuals are not exempt from tax unless a tax or income tax treaty exception applies.

About The Author

Paula Singer, Esq., CEO of Windstar Technologies, Inc. and partner in the tax law firm, Vacovec, Mayotte & Singer, Newton, MA has over 25 years of experience providing advice and compliance services to employers on cross-border employment matters. For more information, visit www.windstar.com. For additional information, call 1-800-259-6398 or email: info@windstar.com

The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.

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