Navigating The U.S. Taxation: A Guide for Non-Resident Aliens

As a non-resident alien living and working in the United States, understanding the U.S. tax system can be a daunting task.

Article Highlights:

• Taxation of Non-resident Aliens
• FDAP Income
• Effectively Connected Income
• Form 1040NR – Non-resident Tax Return
• Form 8233 - Tax Treaty Exemption from Social Security and Medicare
• Form I-9 - Employment Eligibility Verification
• Form W-4 – Employees Withholding Certificate

Form W-7 - Application for IRS Individual Taxpayer Identification Number

As a non-resident alien living and working in the United States, understanding the U.S. tax system can be a daunting task. This guide aims to simplify the process, providing you with a comprehensive overview of your tax obligations, potential tax treaty benefits, and the necessary forms you may need to file.

A non-resident alien is defined for tax purposes as an individual who is not a U.S. citizen and who doesn’t have a “green card” or meet the substantial presence (in the U.S.) test. Additionally, an alien individual who qualifies as a resident of a treaty country (see details in IRS Publication 519) or a bona fide resident of Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or American Samoa is a non-resident alien individual.

Non-resident aliens are taxed on their U.S. source income, which includes both earned income (wages, salaries, etc.) and investment income (interest, dividends, etc.). The tax rates applicable to non-resident aliens are generally the same as those for U.S. citizens and residents. However, the standard deduction is not available to non-resident aliens, except for students and business apprentices from India who meet certain conditions.

• FDAP income – FDAP income stands for Fixed, Determinable, Annual, or Periodic income. It refers to U.S. source non-business income paid to a foreign person or corporation that is not effectively connected income (ECI). This can include salaries, wages, premiums, and compensation for services performed in the U.S., as well as other fixed or determinable annual or periodic gains, profits, and income. FDAP income is subject to a 30% (or lower treaty) tax rate.

It's important to note that a non-resident alien receiving only FDAP income upon which the 30% (or lower treaty) rate has been withheld is not required to file a U.S. income tax return. However, FDAP income can become effectively connected income (ECI) if the income is derived from assets used in or held for the use in the conduct of a trade or business in the U.S., or if the activities of that trade or business in the U.S. are a material factor in the realization of that income.

• Effectively Connected Income - ECI refers to income earned by a foreign individual or corporation from conducting a trade or business within the United States. This income is subject to U.S. income tax and must be reported on a U.S. income tax return. ECI can include income from various sources, such as the sale of goods or services, rental income, or income from investments that are connected to the U.S. business. ECI is taxed at graduated rates and the foreign person would be required to file a U.S. income tax return. However, ECI is not subject to a withholding obligation.
• Form 1040NR - As a non-resident alien, you will typically file Form 1040NR to report your U.S. source income. If you are a partner in a U.S. partnership that was not engaged in a U.S. trade or business during the year, you may receive Schedule K-1 (Form 1065) that includes only income from U.S. sources not effectively connected with a U.S. trade or business.
• Form 8233 - The United States has tax treaties with several countries, which may allow non-resident aliens from these countries to be exempt from certain U.S. taxes. IRS Publication 515 includes Internet links to this information and a IRS website provides additional information.

If a non-resident alien claims a tax treaty exemption from Social Security and Medicare withholding taxes, they must complete a Form 8233 and provide it to their employer. The employer must review, accept, and sign the form, then forward a copy to the IRS within five days. The employer must then wait ten days to see if the IRS has any objections to the exemption from withholding.

• Form I-9 - The purpose of the Form I-9, also known as the Employment Eligibility Verification, is to verify the identity and employment authorization of individuals hired for employment in the United States. This applies to both citizens and non-citizens. Employers are required to ensure proper completion of Form I-9 for everyone they hire. The form serves to document that the employer has verified that the employee is eligible to work in the U.S.
• Form W-4 - All compensation that is not exempt under the tax treaty will be subject to employment taxes in conjunction with the non-resident alien’s Form W-4. This form is subject to special adjustments that consider restrictions on a non-resident alien’s filing status, ability to claim the standard deduction, and restrictions on claiming certain credits and deductions.

Non-resident aliens should review IRS Notice 1392, Supplemental Form W-4 Instructions for Nonresident Aliens, before completing the Form W-4. It's important to note that non-resident aliens cannot write “exempt” in the space below Step 4c of the Form W-4 (2023 version), must enter a Social Security number at Step 1b, and may only claim “single” or “married filing separate” for their filing status at Step 1c, regardless of their actual marital status.

• Form W-7 - A non-resident alien who doesn't have a Social Security Number (SSN) but is required to file a tax return or a statement must apply for an Individual Taxpayer Identification Number (ITIN). The ITIN is a tax processing number issued by the Internal Revenue Service for individuals who are required to have a U.S. taxpayer identification number but who do not have, and are not eligible to obtain, a Social Security Number.

To apply for an ITIN, Form W-7, IRS Application for Individual Taxpayer Identification Number, must be completed and filed according to the IRS instructions. The form should be attached to the federal income tax return for which the ITIN is needed. Please note that an ITIN does not provide work authorization and cannot be used to prove work authorization on an I-9 form. It is used for federal tax reporting only.

Navigating the U.S. tax system as a non-resident alien can be complex. It's important to understand your obligations and potential benefits to avoid penalties and maximize your income. Please contact this office for assistance.