Tax Treaty Benefits For Foreign Students
The United States has income tax treaties with 63 countries. Treaties serve to:
Tax treaty benefits for foreign students vary considerably depending upon when the treaties became effective.
Prior to the 1986 Tax Reform Act, scholarship and fellowship grants for students were exempt from tax. Grants for research scholars were given favorable U.S. tax treatment as well. U.S. students were able to offset work-study income with the standard deduction and personal exemption. Nonresidents cannot use a standard deduction to offset work-study income. U.S. tax treaties from this period generally provide complete exemption from tax for scholarships and fellowships for full-time students. (The former USSR treaty, which covers nine of the Newly Independent States, is the notable exception with a $10,000 treaty maximum.) In addition, they provide for a limited exemption for earned income, typically $2,000 to $5,000, compensating for the lack of a standard deduction. Most treaties limit the student benefits to five taxable years.
To provide tax treatment similar to U.S. citizens for foreign students, a few tax treaties – Barbados, Jamaica, and Hungary – allow students to elect to be treated as residents.
Following the '86 Act, only qualified scholarship and fellowship grants - tuition and required fees, books, supplies, and equipment - are exempt from tax. All other grants are taxable but not subject to withholding or reporting for U.S. citizens and residents. Taxable grants of nonresidents are subject generally to 14 percent withholding and reporting on Form 1042-S. U.S. citizens and residents may use the standard deduction to offset taxable grants on their Form 1040; nonresident students cannot use the standard deduction on their Form 1040NR-EZ. U.S. treaty policy for student benefits does not reflect the difference (except for the treaty with India, which allows students a standard deduction and a personal exemption for a spouse).
U.S. Treaty Policy on Student Benefits
The U.S. Model Treaty states the U.S. policy regarding student benefits:
This limited benefit was included in treaties with Australia, Canada, Italy, New Zealand, Pakistan, and the U.K. (The treaty with Pakistan also includes a $5,000 earned income exemption.) Nonresident students need no treaty benefit for such payments from abroad, which the Rev. Rul. 89-67 deems foreign source.
The replacement treaties with Austria, Denmark, Ireland, Japan, Sweden, and Switzerland incorporate the U.S. treaty policy. The new treaties with Mexico, South Africa, Sri Lanka, and Turkey also incorporate this policy.
The Treasury Explanation for the treaty with the Netherlands notes that: “It is not standard U.S. treaty policy, particularly in treaties with developed countries, to include an earned income exemption for visiting students.” The United States preserves the benefits from prior treaties when they are important to the treaty partner.
The replacement treaties with the Netherlands, France, and Germany preserve both the limited earned income exemption and the exemption for U.S. source grants. (The treaty with Germany includes a retroactive loss provision for earned income if the stay in the United States extends beyond four years.) The replacement treaties with Kazakhstan, Luxembourg, Russia, and the Ukraine preserve exemption for grants regardless of the source.
New treaties negotiated with China, the Czech Republic, Estonia, Indonesia, Israel, Latvia, Lithuania, Portugal, the Slovak Republic, Slovenia, Spain, Thailand, Tunisia and Venezuela - include benefits for scholarship and fellowship grants, regardless of the source and a limited exemption for earned income.
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: firstname.lastname@example.org
The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.