Many people want to know what a non-resident alien tax refers to. In simple terms, non-resident alien tax is the income tax that non-resident aliens have to pay on the income they’ve earned or otherwise realized from the United States. However, before further looking at non-resident alien tax, it’s important to understand a few things. This includes the difference between resident and non-resident alien.
Understanding resident and non-resident alien
Before we look at non-resident alien tax in detail, it’s important to understand the difference between resident and non-resident alien. Permanent legal residents of the United States are referred to as resident aliens. Basically, resident aliens are non-U.S citizens with a green card. On the other hand, non-resident aliens are individuals legally present in the United States without a green card. An example of non-resident aliens would be tourists or individuals residing in the United States on a business visa. Now that we’ve distinguished between resident and non-resident aliens, it’s time to look at non-resident alien tax in detail.
Understanding non-resident aliens and their tax duties
A person without U.S citizenship is referred to as an alien. On the other hand, non-resident aliens are individuals who are yet to pass the Substantial Presence Test or the Green Card Test. Before we proceed further, let’s take a quick look at the Substantial Presence Test.
In simple terms, the Substantial Presence Test is a test used to find out the tax status of a non-permanent resident alien or non- U.S citizen. The tax status is calculated based on the number of days the non-permanent resident alien or non- U.S citizen was present in the United States during a three-year period.
More importance is given to the most recent days spent in the United States while the calculation awards less importance to days further in the past. The Substantial Presence Test is divided into two parts: the 31-day test and the 182-day test. In order to pass the test, a person needs to be present in the United States for a minimum of:
- 31 days during the current year
- 183 days during the previous three years
The individual will be treated as a resident alien for tax purposes if he passes the test. However, if the individual does not meet the above criteria, he or she will be subjected to non-resident alien tax.
If, at the end of the year, you’re a non-resident alien but your spouse is a resident alien, they can help you be treated as a U.S resident alien for tax purposes by filing form 1040 and using the filing status “Married Filing Jointly.”
Filing a tax return
Most non-resident aliens in the United States want to know when it’s necessary for them to file for income tax return. For such individuals, following are the situations when filing for U.S income tax return becomes necessary:
- During the year, you’re involved or are considered to be involved in a business or trade in the U.S. However, you do not need to file if wages amounting to less than the personal exemption amount are your only United States source income.
- You’re a non-resident alien not involved in any trade or business in the U.S and have United States income on which the withholding tax at the source did not satisfy tax liability.
- You’re an agent or representative filing the return for any of the aforementioned non-resident aliens
- You’re a fiduciary for a non-resident trust or estate
- You may need to file an income tax return for another person and also pay the tax if you’re a domestic fiduciary or resident responsible for taking care of a property or person related to a nonresident individual
- You’re a nonresident alien trainee, student or teacher or was temporarily residing in the U.S on an J,M, F or Q visa and had income that is subject to tax i.e. tips, wages, dividends, scholarship and fellowship grants etc
- You want a refund of overpaid or overwithheld tax
- You want to benefit from any credits or deductions
The aforementioned situations are when non-resident aliens must file income tax return. Now that you know about the situations that make filing income tax returns necessary, it’s time to look at the a few important things including the taxable income for non-resident aliens.
Understanding the taxable income for non-resident aliens
Generally, non-resident alien tax is based on the United States source income. Non-resident aliens need to pay tax at the normal U.S tax rates if they have the following income types:
- Income effectively connected with a United States Business
- Capital gains from the U.S real estate sale
No non-resident alien tax is applied to other capital gains unless:
- The non-resident alien is the owner of a United States business
- The non-resident is physically residing in the United States for a minimum of 183 days
Unless a tax treaty is provided, the income from United States investment sources is generally subjected to a thirty percent tax rate.
The income to report for non-resident alien tax
Generally, the income subject to non-resident alien tax is divided into two categories. The two categories are:
- The income effectively connected with a business or trade in the U.S
- Fixed, Determinable, annual or periodical (FDAP) U.S source income
After deductions are made, taxes will be applied at graduated rates for effectively connected income, which are the same rates applicable to U.S residents or Citizens. The first page of Form 1040NR, U.S Nonresident Alien Income Tax Return is where effectively connected income should be reported.
Generally, passive investment income is what FDAP consists of. However, in theory, any sort of income can be a part of FDAP. No deductions are allowed against FDAP and it is taxed at a fixed 30%, or if applicable, a lower tax treaty rate. The fourth page of Form 1040NR is where FDAP income should be reported.
The form to file
In order to file an income tax return, non-resident aliens must use:
Treatment of non-resident for tax purposes
Any income earned or otherwise realized by non-resident aliens from a United States source is subjected to non-resident alien tax. You must pay U.S tax on the income you earn from the United States after allowable deductions have been made if you’re a non-resident alien involved in a U.S trade or business.
The same tax rates that apply to U.S residents and citizens will be applicable to you. However, you don’t have to pay tax on any income earned from a source. For example, you own a business in France and another in the United States. Now, for tax purposes, the U.S tax authorities will ignore your French business and will consider the U.S business instead.
A flat 30% non-resident alien tax is applied to the fixed, annual, periodical, or determinable U.S source income and no deductions are allowed against such income if you aren’t involved in a trade or business. Both fixed annual, periodical, or determinable income and effectively connected income may be earned by you in the same year. Furthermore, they’ll be taxed accordingly.
Instead of filing a joint return, spouses of non-resident aliens can opt to claim the later as dependents in some cases. Furthermore, to ensure that the IRS is able to clearly determine what is exempt and what should be tax, non-resident aliens must maintain careful records of all income sources.
When and where to file for non-resident alien tax return
Generally, you must file for income tax return prior to the 15th day of the fourth month after your tax year ends if you’re an employee or self-employed person who receives wages or compensation other than employee income that is subject to United States tax withholding. You must also file as a non-resident alien for income tax return before the aforementioned date if you have a business in the U.S.
On the other hand, you must file prior to the 15th day of the sixth month after your tax year ends if you’re self employed (and receiving wages as compensation, or any other form of compensation that doesn’t come under regular employee earnings), or aren’t employed, and you don’t own any business in the U.S.
Non-resident aliens need to file for income tax return using Form 1040NR and 1040NR-EZ.
The consequences of not filing for income tax return for non-resident aliens
According to studies, most non-resident aliens who need to file for income tax return, either avoid filing a return or file inappropriately. However, studies also reveal that rather than underpaying, non-resident aliens who do not file end up paying massive U.S taxes.
It isn’t 100% that you’ve paid the appropriate amount in case your employer has withheld tax from your wages. There is a big chance that you have a big refund due! Also, you might be wondering what will happen to you if you do not file a return and don’t have any tax liability. Well, if no tax is due, the IRS will not impose any penalties. Nonetheless, your visa terms make complying with all United States laws mandatory for you. This includes filing for an income tax return.
Also, if you desire obtaining permanent residency, changing your visa status or regaining entry into the U.S once you’ve left, you might have to provide proof that you’ve filed for an income tax return. You should not compromise your visa status by failing to comply with the aforementioned requirement.
Unless you file your income tax return accurately and on time, you won’t get the benefit of any allowable credits or deductions. For the aforementioned purpose, you must file an income tax return within sixteen months of the due date. If you file later than sixteen months after the due date of the tax returns, the IRS has the right to deny you credits and deductions on the returns. If you want to find out more about this, you can refer to Publication 519, U.S. Tax Guide for Aliens.
Tax on non-resident aliens’ business income
Business and non-business income of non-resident aliens is treated differently by the United States tax laws. Also known as ETCB income, business income refers to income such as profits, commission, and wages from a business or trade which actively involves the taxpayer. Form 1040NR is what a non-resident alien of the United States needs to file.
Based on a graduated rate system, the U.S source income of the aforementioned non-resident alien is taxed on net basis. The tax rules for a United States citizen are what the tax and taxable income calculation are similar to. Also, similar tax rates apply to Form 1040 and 1040NR. However, exemptions for spouse and dependents are not allowed by 1040NR during calculation of taxable income. Furthermore, the form doesn’t permit any standard deduction.
Tax on non-resident aliens’ non business related income
Income earned from investments such as dividends and interest from securities, options, securities, stocks etc that are publicly traded is included in non-business income of FDPI of non-resident aliens. Usually, a thirty percent flat tax rate on a gross basis is what the non-resident aliens’ non-business related income is taxed at. Furthermore, if the thirty percent from the source is withheld, a U.S tax return does not generally have to be filed by a non-resident alien with only United States income.
Generally, for trusts, estates, or individuals, the rate is twenty-eight percent. On the other hand, for non-passive income distribution to foreigners, the rate is thirty-four percent.
Understanding an exempt individual
Usually, non-resident alien filing 1040NR can avail only one exemption for him-self. Non-resident aliens cannot claim exemption for their children or spouse. The US tax treaties with Japan, India, South Korea, Mexico, and Canada allow certain exemptions. As a non-resident alien, if you’re a citizen of the aforementioned countries, you may be able to claim exemption for your children or spouse.
It is important for you to keep in mind that an exempt person doesn’t refer to an individual exempt from paying tax rather it refers to being exempt from the days from the substantial presence test. Following individuals are exempt from SPT for non-resident alien tax:
- A person temporarily residing in the U.S for foreign-government related purposes
- A trainee or teacher temporarily residing in the U.S under a Q or J visa and who complies with the visa requirements
- A student temporarily residing in the U.S under an M, Q, J, or F visa and who complies with the visa requirements
- A professional athlete temporarily residing in the U.S for competing in a charitable sports event
Tax deductions for non-resident aliens
Unless the country they are citizens shares a relevant treaty with the United States, non-resident aliens aren’t eligible for standard tax deductions. However, in a manner similar to residents, they can benefit from itemized deduction on non-resident alien tax. The way of deducting foreign tax is similar to the method used for local or state tax paid. Alternatively, as a non-resident alien, rather than the deduction, you can choose to sign up for a foreign tax credit.
Understanding Income tax treaties
There are many countries that enter into tax treaties to avoid double taxation. These treaties ensure knowledge sharing between treaty nations, favorable income exclusion, and reduced withholding tax rates. Currently, the United States shares treaties with:
- Czech Republic
- New Zealand
- Slovak Republic
If you’re interested in getting non-resident alien tax deductions then you must check the lowered withholding tax rates and similar advantages for the country you belong to. By checking your home country’s tax treaty with United States, you may be able to get great tax savings.
The aforementioned information is only a small part of the tax rules that apply non-resident alien income. If you want to get all the details about non-resident alien tax then you must contact the IRS or at least visit their website to access the relevant sources. As a non-resident alien, you’ll find contacting the IRS or visiting their website extremely useful. This will help you to find out everything you want to know about non-resident alien tax.