Taxed Payroll Rules for Nonresident Aliens

Dealing with immigration issues in a vacuum can result in serious tax consequences. U.S. income tax and payroll withholding rules differ significantly depending on an employee's status as either a resident or nonresident. These are tax terms not immigration terms. Employees entering the U.S. on H, L or J visas may qualify for either status. A foreign national’s tax status is determined by their U.S. immigration classification and days of physical presence in the U.S. under complex tax rules.

A. U.S. Tax Status: Resident, Nonresident and Dual

The following rules are general guidelines and the facts and circumstances should be reviewed in each case.

1. A foreign national holding a green card is a resident alien.
2. An F, J or Q student in the U.S. for less than 5 calendar years or a foreign national on a foreign government-related visa, such as A-1 or G-1, is a nonresident alien.
3. A non-student holding a J or Q visa previously in the U.S. on a F, J, or Q status for 2 (sometimes 4) years, in the previous 6 years is a resident alien.
4. A foreign national who meets the "substantial presence test" is a resident alien. The test is met if the foreign national is present in the U.S. for 183 days of the current year or 183 days in the current and prior 2 years based on the formula counting all of the days in the current year plus one-third of the days in the prior year plus one-sixth of the days in the second preceding year.

In addition, special rules may apply which can give the foreign national "dual status" in the first and last years of physical presence in the U.S. A "dual status" alien is a part-year resident and part-year nonresident. Classification of an alien employee as either resident or nonresident can be extremely complicated to determine in their first year of arrival to the U.S. The IRS wage withholding regulations and IRS Publication 515, "Withholding Tax for Nonresident Aliens and Foreign Corporations," contain little guidance for employers to determine whether an employee is a nonresident alien or resident alien in the arrival year. In fact, the employee's tax status may not be known until after December 31st of that first tax year.

A nonresident alien may be entitled to a special election to file as a resident alien or to file a joint return. These elections are generally not made until the alien files his or her U.S. income tax return. Depending on the circumstances, these elections can generate significant tax savings. After the first year of entry into the U.S., most non-immigrant aliens on temporary assignment to the U.S. will be classified as resident aliens, unless they travel extensively outside the U.S.

In practice, the burden of claiming resident or nonresident alien status may be placed on the employee. As an added protection in the event of IRS audit, however, the employer may request a written statement from the employee in support of his or her claim of resident or nonresident status.

B. Key Payroll Rules for Nonresidents

The wage withholding rules for nonresident aliens are unique. The primary differences from the rules for resident aliens are as follows:

• they must use single wage withholding tables;
• they are entitled to only one exemption (there are exceptions for residents of Canada, Mexico, Japan and South Korea);
• they may claim only certain itemized deductions, not the standard deduction; and
• an additional $7.60 per week must be withheld; and
• they are taxed only on compensation from U.S. sources, which include wages and salary allocable to U.S. workdays.

Technically, if a nonresident performs work outside the U.S., the employer should not withhold tax from salary allocable to those non-U.S. business days. Most payroll systems, however, are unable to automatically track U.S. and non-U.S. workdays in any single payroll period. Therefore, if the number of days can be accurately estimated at the start of the U.S. employment, a withholding adjustment can be made and a wage withholding "true-up" made at year end.

Certain remuneration for services performed by nonresident aliens within the U.S. may be exempt from wage withholding under the Internal Revenue Code or an income tax treaty. In the case of remuneration for services within the U.S. by an employee, the nonresident employee must supply his or her employer with a completed IRS Form 8233 to claim exemption from U.S. tax liability on wages allocable to U.S. work days.

In addition to certain income tax exemptions, both resident and nonresident aliens may be eligible for exemptions from U.S. social security taxes. There is a specific exemption from U.S. social security coverage for nonresident aliens who are in the U.S. under an F, J or M visa. The U.S. has also entered totalization agreements with 18 countries. Where an employee is transferred to the U.S. for a temporary period (usually up to 5 years), he or she can remain in the home country system and qualify for an exemption in the U.S. by obtaining a Certificate of Coverage from the home country.

The rules of taxation are complicated and the liabilities for not following them are significant. GT has expert international tax attorneys to facilitate companies in understanding the intricacies of the law and applying.

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