www.arcticintl.com ARCTIC INTERNATIONAL LLC Nonresident Alien Tax Compliance A Closer Look The Who, What When, How and Why... NACUBO Tax Forum 2013
Who... is required to withhold and report?... is a Nonresident Alien? What... payments are affected?... is the tax rate? When... can tax withholding be avoided? Session Overview How... do I report payments to nonresident aliens?... do I document everything? Why... is this important?
General Rule ALL withholding agents (for example, an employer) MUST withhold federal income tax from ALL income payments made to or on behalf of a nonresident alien individual or entity (Section 1441 of Internal Revenue Code); IF the withholding agent DOES NOT withhold the appropriate amount of tax at the time of payment, the withholding agent will be liable for the tax, plus any penalties and interest regardless of whether the individual pays the tax on his or her tax return (Section 1461)
Working Through a Situation What are the Facts of the Situation? What is the Payee s U.S. Tax Residency Status? What Type of Income is Being Paid? What is the Source of the Income? Is the Payment Subject to Tax Withholding? At What Rate Should Taxes Be Withheld? Is an Income Tax Treaty Exemption Possible? Is the Payment Exempt From FICA Tax? Is the Payment Reportable? If so, on What Form(s)? How Should the Information Be Maintained?
An Overview of the Tax System U.S. Tax System Nonresident Alien Tax System Residency Status U.S. Citizen/U.S. Entity Lawful Permanent Resident Resident Alien for Tax Purposes Nonresident Alien Individual/ Entity for Tax Purposes
Paying Nonresident Alien Individuals
Identification of NRA Population It is relatively simple to identify a U.S. citizen or Permanent Resident Alien; however, there is only one method that can be used to identify a Resident Alien or Nonresident Alien for tax purposes: The Substantial Presence Test
The Substantial Presence Test Based on the mathematical results of the substantial presence test, an individual is a: Resident Alien for Tax Purposes if he or she has 183 days or more of U.S. presence; OR Nonresident Alien for Tax Purposes if he or she has 182 days or less of U.S. presence. There are several exceptions to how to the Substantial Presence Test is calculated.
Determining U.S. Residency Status To Determine an Individual s Residency Status, You Need Four Facts About the Person: Current Immigration Status Primary Purpose of Presence in the U.S. Date of Arrival for Purposes of This Visit Information About Prior Visits (including all of the facts above)
What Types of Payments are Income? If you are making a payment and you are not certain what type of income is being paid, then put down your pen and DO NOT make the payment until you have enough facts to determine the type of income!
Compensation Dependent Wages / Salary / Stipend Travel Reimbursement / Payment Independent Ind Per Services / Consulting Fees Honoraria / Guest Speaker Fees Travel Reimbursement / Payment Scholarships/Fellowships Tuition / Fees Room / Board Stipend Book Allowances Travel Reimbursement / Payment Royalties Prizes or Awards What Income is Taxable? Taxable / Treaty Exempt Accountable Plan Taxable / Treaty Exempt Taxable / Treaty Exempt Accountable Plan Excluded under 117 Taxable / Treaty Exempt Taxable / Treaty Exempt Excluded under 117 Taxable / Treaty Exempt Taxable / Lower Treaty Rate Taxable
Are Travel Expenses Taxable? The Accountable Plan Rules ONLY Apply when there is a compensatory relationship (Employees and Independent Contractors who receive compensation) The Accountable Plan Rules DO NOT Apply if there is no compensatory relationship (Students and Scholars who receive Non-Service Scholarships and Fellowships)
Tax Withholding Responsibilities All income paid to a nonresident alien or a third party on his or her behalf are either: EXEMPT Foreign Source Internal Revenue Code Income Tax Treaty OR TAXABLE Graduated Withholding at S, 1, + add. taxable base amt. (Employee Compensation) 14% (Scholarships/ Fellowships to F, J, M, & Q Immigration Status) 30% (Non-Employee Compensation and all Other Payments) Arctic International LLC 2013. 2006. All Rights Reserved
Tax Withholding Responsibilities Compensation paid to nonresident alien employees is subject to restricted graduated withholding rates. Form W-4 must be completed in a special manner; withholding agents may not accept Form W-4 from potential nonresident alien if incorrectly completed. If withholding agent does not have properly completed Form W-4, must withhold at maximum tax withholding rate of S, 0. Both the additional amount to be added and the manner by which the additional amount is calculated changed in 2011.
General Reporting Rule A Nonresident Alien Should Receive: Form 1042-S AND/OR Form W-2 NEVER Form 1099
U.S. Tax Reporting Responsibilities Form 1042-S Reports: and All Employee Compensation Payments That Are Exempt From Taxation Under an Income Tax Treaty All Income, Other Than Qualified Non-service Scholarships, Paid to a Nonresident Alien Regardless of Whether the Payment Is Taxable (Section 1441 regulations specifically exclude qualified portions of a scholarship from reporting)
Paying Nonresident Alien Entities
Who Is the Payee? Foreign Individual Foreign Company Foreign Government Foreign Exempt Organization Category of Recipient
Payments to Foreign Entities If payment for goods, no withholding or reporting is required If other type of payment (e.g., for services or royalty) generally 30% tax withholding Report on Form 1042-S Possible Tax Treaty Exemptions (via Form W-8BEN) Royalty Independent Personal Services Business Profits
Effectively Connected Income ( ECI) If engaged in a U.S. trade or business (USTB), income generated in U.S. is ECI. No tax withholding on ECI if paid to non-individuals (Treas. Reg. Section 1.1441-4 (a)(1)). Exclusion from tax withholding does not apply to personal services income paid to an individual. Form W-8ECI used to claim ECI exclusion and must contain a U.S.-issued TIN or ITIN. Collect Form W-8ECI prior to payment. ECI payments must be reported on Form 1042-S using Exemption Code 2.
Royalties What is the residency status of the payee? Is location of the payee relevant? What is the appropriate rate of tax? Can the income be excluded or exempted (income tax treaty)? If so, how should it be documented? Taxpayer Identification Numbers Is the payment reportable? If so, on what form?
Payments to Foreign Performers/Agents Withholding agents who make a payment to a U.S. person with actual knowledge that a U.S. person is an agent for a foreign person must treat payment as made to the foreign person. (Treas. Reg. Section 1.1441-1(b)(2)(ii) ) Conclusion: If the payment is made to a U.S. agent on behalf of a foreign performer(s), withhold and report as if the payment were made directly to the foreign performer(s)
Payments to Foreign Performers/Agents Practical Issues: When do you have actual knowledge? What about the agent s commission? What if there are multiple performers that receive different amounts? What about income tax treaty exemptions? Is there a Central Withholding Agreement
Taxpayer Identification Numbers Does a Foreign Entity Need a U.S. Taxpayer Identification Number? What is the Applicable U.S. Taxpayer Identification Number? EIN ITIN
Which Form? Form W-8BEN (to be updated) Form W-8BEN-E (only in draft, to be released) Form W-8ECI (to be updated) Form W-8EXP (to be updated)
Reporting Issues U.S. Sourced Independent Compensation is reported on Form 1042-S, Income Code 16 Exemption Code 04 if Tax Treaty Exempt ECI Independent Compensation is reported on Form 1042-S, Income Code 16 using Exemption Code 01 Foreign Sourced Independent Compensation is not reported Income paid to Nonresident Alien Exempt Organizations is reported on Form 1042-S, Income Code 16/50 Exemption Code 02 Royalties are reported on Form 1042-S, Income Code 10 (Industrial) or 12 (Copyright) Income paid to Performers is reported on Form 1042-S, Income Code 42 or 43
Payments to Nonresident Alien Non-Individuals and Foreign Entities Category of Recipient How to Withhold Tax How to Report Foreign Entity Receiving Payment for Goods No Tax Withholding; Taxes Handled Through Import Duties No Reporting Foreign Corporation (02) Foreign Partnership (03) If Effectively Connected Income Form W-8ECI No Tax Withholding Form 1042-S Exemption Code = 01 Foreign Government (06) Foreign Exempt Organization (07) IF International/Exempt Organization Form W-8EXP Form 1042-S Exemption Code = 02 Foreign Corporation (02) Foreign Partnership (03) Foreign Trust (05) Foreign Private Foundation (08) Foreign Estate (10) If Tax Treaty Exempt Form W-8BEN No Tax Withholding Form 1042-S Exemption Code = 04 Foreign Entity 30 percent Form 1042-S Exemption Code = 00 Tax Withholding Shown
Why Is This Important? Are You Confident in Your Current Tax Compliance Posture? Are You Keeping Track of Changes in the Law and in Your Programs...and Making Any Necessary Adjustments to Your Policies and Procedures? When Was the Last Time You Did an Internal Review or Mock Audit Just to Make Sure? Are You Ready for an IRS Review?
Best Case Why Is This Important? You conduct Self Review (No IRS Auditors On Campus) You determine any gaps/weaknesses and fix them You implement or update Policies and Procedures and conduct internal training
Worst Case Why Is This Important? IRS auditors on campus full scale audit Scope broadened Additional issues added IRS calculates tax liability You must reconcile Policies and procedures not implemented You must implement polices and procedures before settlement accepted by IRS Years added to initially reviewed years
Why Is This Important? Big Picture Written Policies and Procedures Efficient Paper Flow and People Flow Process in place Internal and Departmental Training Periodic Internal Review or Sampling Details Designated Responsible Person(s) Step-by-Step Review of Each Situation Appropriate Tax Withholding and Reporting Substantiation Tax File with Appropriate Documentation
How Should I React? What Issues Should Your Institution Consider BEFORE a Possible Interaction With The IRS? Do you have written nonresident alien policies and procedures? Are they UPDATED on an annual basis? When was the last time they were updated? Is there a designated Nonresident Alien Tax Specialist? Does he or she receive regular training, updates, and access to information? When was the last internal review / Mock Audit performed? Were the resulting issues addressed? What communication is sent to Departments about tax issues? When did you last hold information sessions/training for Departmental Administrators? Who prepares the Open Doors data report? Is the tax specialist aware of reports made to USCIS / SEVIS? Are IRS agents invited to the institution during tax season? How are issues that arise during this time managed? Are your files complete, up-to-date, and ready for review? Arctic International LLC 2010. All Rights Reserved
www.arcticintl.com ARCTIC INTERNATIONAL LLC Nonresident Alien Tax Compliance A Closer Look The Who, What When, How and Why... NACUBO Tax Forum 2013