Individuals residing in the US are classified in a set of different categories for tax purposes. The top tax body of the United States, i.e. the’ Internal Revenue Service or IRS defines an alien is an individual who is not a U.S. citizen.
All aliens are further classified into one of two categories that include ‘nonresident aliens’ and resident aliens. “Resident aliens generally are taxed on their worldwide income, the same as U.S. citizens. Non-resident aliens on the other hand, are taxed only on their income from sources within the United States and on certain income connected with the conduct of a trade or business in the United States.”
Resident and nonresident aliens
Here an alien is defined as any individual who is neither a U.S. citizen nor a national of the U.S., while a nonresident alien is someone (does not apply to a US national or US citizen) who has not passed the ‘substantial presence test’ or the’ green card’ test. Furthermore, non resident aliens are also those people who are legally present on United States territory but do not possess a valid green card. Such a category includes students, tourists etc. or any other visitor to United States territory, who is in possession of a valid visa for a fixed time period only. (Such as 5 year multiple entry and exit visas).
The requirements of taxation of nonresident aliens include certain protocols:
- A nonresident alien individual engaged or considered to be engaged in a trade or business in the United States during the year.
- The U.S. income source is a salary that after being annualized comes to an amount that is less than the (minimum) personal exemption amount, then in such a cause the non resident alien would not be required to file.
Any nonresident alien who is not engaged in any sort of legitimate business or trade in the United States and while simultaneously having income earned in or though the U.S on which the overall tax liability was not satisfied courtesy the withholding of tax at the source that led to the income generation needs to file his or her tax returns.
- A fiduciary (here the term describes the relationship between a trustee and a beneficiary) for am estate or trust established by a nonresident alien
- A resident or domestic fiduciary, or for that matter any other individual who has been given the charge of taking care property of a nonresident alien would also be required to file the income tax return for that alien.
Special Circumstances when the income tax bracket is below minimum wages
Even if your income bracket is below the minimum listed (to be determined by age and status) it is incumbent on you to file a tax return if you fall into any of the following “special circumstances” categories.
- If you owe household employment taxes
- If the self-employment earnings totaled an accrued amount of at least $400
- If you owe ‘Alternative Minimum Tax’
- If you owe tax on a health savings account
- If you owe tax on a retirement plan
- If you earned at least 108.28 dollars from any organization that happens to be either Church run or is Church controlled entity
- If you received (periodic) distributions from either one or more ‘Health Savings Accounts’
- If you are legally bound to Homebuyer Credit
- Any agent and/or representative directly or indirectly responsible for filing the (income tax) return of such an individual
- If you owe Social Security/Medicare taxes on any income (or incomes as the case may be) that remain unreported.
The multifold taxation requirements for nonresident aliens
For tax related purposes in the U.S, all nonresident aliens are only required to pay income tax on any and all incomes that are earned only through a U.S. source (or sources). This is why it is not considered necessary for them pay tax on any income (profits wages, and revenue) earned through other sources located over seas.
Let us take the example of Mr. John Smith a non resident alien from Nigeria. If Mr. Smith owns a small business in Nigeria and another one that is located on US territory then Mr. Smith would not be taxed on the former but would have to pay taxes only for the business that he legally owns in the U.S. In other words, his Nigerian business is of no concern to the tax authorities in the United States. For people like Mr. Smith there are many different relief measures in place and this is why the tax authorities allow them to claim their spouses as dependents in certain cases instead of filing a joint return.
It is considered prudent when dealing with taxation for non resident aliens to keep careful records of US business and trade related activities so as to be able to disclose the principle sources of all of their income to enable the Internal Revenue Service to clearly pinpoint precisely what should be taxed and what should be exempted from all such taxation.
Taxation policies regarding the marital status of non resident aliens
For taxation purposes all non resident aliens are divided into two different categories that are:
- Single nonresident alien
- Married nonresident alien
A non resident married alien who is desirous of filing his or her returns jointly with the spouse should be aware that it is not possible to do so if the spouse was a non-resident alien at any point in time, during the year the tax assessment is taking place. However, all non-resident aliens who have a spouse who is a US citizen (irrespective of gender), have been given the choice of being treated as U.S. residents and therefore have the right to file tax returns jointly. According to the revenue code as practiced in the U.S it is not permissible to file tax returns as head of household if the person doing so is a nonresident alien during the time period in which the tax assessment takes place.
Most deductions are not applicable for non-resident aliens and that is why it is not permissible for them to try and make any claims for the same. However, there is a cravat for business apprentices as well as students from India who may be eligible to claim such a deduction under Article 21 of the “U.S.A India Income Tax Treaty.”
It should be noted that non-resident aliens are allowed to subtract only those (case by case) deductions if they in receipt of any and all incomes and profits that have been acquired either though a connection with their U.S. business or from plying a trade located in the US. Some deductions include:
- All state and local income taxes (wherever applicable)
- Any form of charitable contributions that have been made to non profit organizations in the United States
- The annual expenses that are deemed necessary (for tax purposes only) for the running of an American business or trade on a ‘month on month’ basis.
- Losses that are a result of either theft or unforeseen calamity or any other casualty
- Miscellaneous deductions (to be decided on an item by item basis)
Claiming deductions (wherever applicable)
For the purpose of claiming all those deductions that, as you are entitled to, as a non resident alien tax payer, you should use the IRS’s Schedule A of Form 1040NR to. However, if you were to be required to file your returns Form 1040NR-EZ, then it is necessary that you should be aware that you can only claim a specific deduction for state or local income taxes (as they exist in that particular state or county).
Claiming itemized deductions (On an item to item basis)
For the purpose of claiming such deductions you should use the IRS’s Schedule A of Form 1040NR to. On the other hand, should you be filing Form 1040NR-EZ, then you should be aware that you can only claim a specific deduction for state or local income taxes according to the tax codes prevalent in that state or district. If you intend to file a claim to any other types of deductions it is mandatory for you to file Form 1040NR.
Major differences between resident and non resident tax returns
If the individual files his returns as per the instructions applicable on form 1040 only (this form applies to U.S. resident returns), then it is imperative for him to report all his incomes since the same are subject to taxation in the United States (irrespective of the fact that the source of the income may originate in any other country all over the world) However, this requirement does not apply to non-resident individuals, who are required to file their returns on form 1040NR (non residents) Such individuals only need to report that part of their income that has been sourced in the United States only.
However, this condition also applies to all foreign nationals who have invested in the US, in other words, if a non resident alien visits the U.S and said visit makes him or her a US tax resident for tax purposes, then all income accrued form any legal sources all over the world would automatically be subjected to income tax.
For Form 1040, both US citizens and the holders of valid Green cards (a permit issued by the United States government that allows individuals to live and work in the United States on a permanent basis) have minimum filing requirements. There is no set minimum income for filing a return; this is because the taxable amount varies according to both age as well as filing status.
Quite unlike U.S. residents, the cravat for a minimum income threshold for filing tax returns for non resident aliens does not apply, as long as they receive income from U.S. sources. However, for all such non resident aliens who are involved in business or trade in United States Territory, it is obligatory for them to file returns irrespective of the fact that they may have accrued no income from any business or trade conducted in the U.S. This applies even if there were to be any actual income and said income is exempt from U.S. tax under a tax treaty or any section of the Internal Revenue Code.
Tax implications for non resident aliens
All tax assessments for any foreign individual (irrespective of country of origin) will depend on that individual’s classification as either a non-resident or a resident alien.
In the case of all non-resident aliens, the individual s would be subjected to certain criteria, some of which also include:
- The non resident alien person cannot be in possession of a valid green card at any time during the relevant period under assessment (typically annualized around a 12 month calendar year)
- A non resident alien must not have resided in the U.S. for more than 183 days (maximum) in the past 3 year period. (This would also include the current reporting and assessment period as well).
- Nevertheless all non-U.S. citizens who are in possession of valid green cards (another term for a United States Permanent Resident Card) and have been on United States territory for a period exceeding at least 183 days would be considered to be resident aliens, at least with regard to the evaluation of their tax returns, and as such would have to follow all the rules and regulations in place that govern the tax returns of all resident aliens in United States under the existing laws (As and when applicable)
Here if any foreigner in the United States on a valid visa for a limited period of time were to be classified as a ‘non-resident alien’ and his only business activity would consist of the involvement in the trading and holding of non tangible trading assets (such as mutual funds, stocks, commodities and other associated non tangibles ) within the ambit of a United States dollar denominated brokerage firm or any other agent operating as per the same guidelines, then such an individual’s income would be considered to fall under the domain of the following tax principles.
Taxation on Capital gains on income accrued by nonresident aliens
In terms of all capital gains (here a capital gain may be described as an overall increase in the value of a capital asset such as an investment in stocks or commodities that is actualized only when the asset is sold for either a profit or a loss, as the case may be) that are accrued by non-resident aliens, it is pertinent to note that these are not subject to U.S. capital gains tax on the profits that said nonresident alien may have accrued from this sale. Since such a tax is not applicable to the foreign country based investor/shareholder, no tax may either be deducted from is accrued income or withheld at source by either the brokerage firm or the agent acting on behalf of such a firm or company.
However, this cravat does not authorize the non resident alien to have a blanket ‘carte blanc’ to continue to trade without being made to pay any taxes whatsoever. This is because he or she would inevitably be taxed in his or her country of origin and/or current residence.
Here it is important to clarify that all dividends payable (on stock owned by non resident aliens) are subjected to the uniform dividend tax rate of thirty percent. This tax is applicable on any and all dividends that are paid by joint stock companies incorporated in the United States, to all their share holders, including non resident aliens residing in foreign countries. However, such dividends may be beyond the ambit of this 30% tax if the dividends are paid by overseas companies or alternately, if such dividends are short term capital gain dividends or even interest related dividends.
In addition to the above, this thirty percent flat rate is also subject to certain terms and conditions that are entirely dependent on the treaty obligations between the country of origin of the non resident alien as well as the government of the United States.
This is why when we consider the taxation of Nonresident Aliens, it is imperative to read and understand all the relevant treaty obligations between the home country and the United States. This holds especially true for people of Indian origin as well as many South Koreans because these two countries have also signed multiple tax related treaties with the U.S government.
Why it is so important to file tax returns fro non resident aliens
When we consider the taxation of non resident aliens we would realize why it is so important for them to file such returns. Many non-residents simply do not bother to file their returns because they believe that they do not owe anything. However, that is not the case and it often happens that the amount withheld from the non-resident’s paycheck is over and above the monies that would be their just due at the end of the assessment period. This means that not filing the return would effectively mean that all subsequent refunds would be lost (more or less) permanently.