Nonresident alien or Resident alien for 2019 US income tax purposes (Part 1 of a series)

Nonresident alien or Resident alien for 2019 US income tax purposes (Part 1 of a series)

An intimidating question for those with little or no experience with US tax rules.  Even if they don’t completely understand the rules, they do understand that their resident/nonresident status may have a big impact on them.

Caveat:  There are multiple additional implications beyond US federal income tax (e.g., immigration status, disclosure requirements, state/local taxation, gift/estate taxation, etc.) that are beyond the scope of this writing.  Be sure to check back soon, as I plan to discuss these areas in more detail in the future.

KEY POINTS

• Talk to an experienced tax professional about these and related rules and how best to approach them.  For example, aliens can be both nonresident and resident in their first/last resident year (“dual-status”) so determining residency start/end dates can be very important.
  
• Rules are mostly mechanical, but can be complicated. 
• Only applies to US noncitizens.  US citizens are not “aliens,” so resident/nonresident status is moot.
• Internal Revenue Code section 871 imposes income tax on nonresident alien individuals.
• Treas. Reg. section 1.871-1(a) provides that resident alien individuals are generally taxable the same as US citizens.
• Section 7701(b)(30) provides the definitions of “resident alien” and “nonresident alien.”
• In general
• A resident alien an individual that meets any of the following requirements:
• US lawful permanent resident at any time during such calendar year.  Also known as the “green card” test.
• Meets the “substantial presence test” of section 7701(b)(3).
• Makes specific election to be treated as a resident alien.
• A nonresident alien is an individual that is not a resident alien.

DISCUSSION

Section 871 imposes income tax on nonresident alien individuals.  Income subject to US tax is generally limited to income from US sources (e.g., covered by section 861 – services performed in the US, interest/dividends from US payors, etc.).  Tax rate is generally 30% for income not connected with US business and the regular graduated tax rate for income that is connected with a US business.

Treas. Reg. section 1.871-1(a) provides

• “Resident alien individuals are, in general, taxable the same as citizens of the United States; that is, a resident alien is taxable on income derived from all sources, including sources without the United States.”

Note:  A nonresident alien may also be subject to a 30% tax rate on capital gains if they are (1) not effectively connected with a US business, and (2) the nonresident alien is present in the US for 183 or more days during the tax year.  If the nonresident alien satisfies the 183-day test, all US-source capital gains and losses for the year are considered, even if they occurred while the individual was not present in the US.

Resident Alien status requirement #1 – Lawful Permanent Resident / Green Card

• Section 7701(b)(1) and (2)
• See also IRS Publication 519 (US Tax Guide for Aliens)

This test is straightforward. 

You are a lawful permanent resident of the US at any time if you have been given the privilege, according to the immigration laws, of residing permanently in the US as an immigrant. You generally have this status if the US Citizenship and Immigration Services (“USCIS”) (or its predecessor organization, “INS”) issued you an alien registration card, also known as a “green card.” You continue to have resident status under this test unless the status is taken away from you or is administratively or judicially determined to have been abandoned.

Resident Alien status requirement #2 – Substantial Presence Test

• Section 7701(b)(3)
• See also IRS Publication 519

This test is more detailed, but still mostly mechanical with relatively little left to interpretation.

For purposes of this test:

• “US” generally includes all 50 US states, DC, and a few other geographies, but not US possessions/territories or US airspace.
• When counting days of presence in the US, you are treated as present in the US on any day you are physically present in the country at any time during the day, with certain exceptions. Do not count the following as days of presence in the US for the substantial presence test.
• Days you commute to work in the US from a residence in Canada or Mexico if you regularly commute from Canada or Mexico.
• Days you are in the US for less than 24 hours when you are in transit between two places outside the US.
• Days you are in the US as a foreign vessel’s crewmember, under a NATO visa, or are otherwise exempt as set forth in IRS Publication 519.
• Maintaining a “closer connection” to a foreign country in which you have a tax home may allow you to be an NRA even if you do meet the substantial presence test.

You will be considered a US resident for tax purposes (for 2019) if you meet the substantial presence test for calendar year 2019. To meet this test, you must be physically present in the US on at least:

• 31 days during 2019, and
• 183 days during the 3-year period that includes 2019, 2018, and 2017, counting:
• All the days you were present in 2019, and
• ¹/₃ of the days you were present in 2018, and
• ¹/₆ of the days you were present in 2017.

Closer Connection – Even if you meet the substantial presence test, you can be treated as a nonresident alien if you meet all of the following criteria and file Form 8840 (subject to certain limitations):

• Are present in the US for less than 183 days during the year,
• Maintain a tax home in a foreign country during the year, and
• Have a closer connection during the year to one or more foreign countries in which you have a tax home than to the US.

Resident Alien status requirement #3 – Affirmative Election

• Section 7701(b)(4)

An individual may also make a “first year election” to be treated as a resident alien for the portion of their first year of US presence in the following circumstances.

• Not a US resident under the green card test or the substantial presence test for the election year,
• Wasn't a US resident under either test for the calendar year immediately before the election year,
• Is a US resident under the substantial presence test for the calendar year immediately after the election year,
• Is present in the US for at least 31 consecutive days in the election year (“31-day period”), and
• Is present in the US for at least 75% of the days during the period beginning on the first day of the 31-day period and ending on the last day of the election year.

Key Takeaways

• Determining Nonresident alien vs. Resident alien status is very fact-dependent and can be very complicated.
• Only applies to US noncitizens.  US citizens are taxed on their worldwide income.
• Individuals sometimes can choose their status.
• Mistakes in this area can be very costly, be sure to discuss with an experienced international tax professional.

Withholding on prizes and awards to US nonresidents

Prizes and awards to US nonresidents may be subject to US income tax withholding!

The long arm of the US tax law can reach unexpected places. 

Did you know that awarding prizes (cash or otherwise) to non-US persons might require you to withhold US federal income taxes and pay them over to the US Treasury?  Moreover, failure to do so may result in the person who should have withheld those taxes being responsible for the unpaid tax!

If that weren’t enough, that requirement can also apply to those who simply administer the prize/award program for someone else (even if they aren’t the one choosing the winners).

Example

• COMPANY (based in the US) runs an entertainment website.
• The website has visitors from around the world.
• COMPANY periodically runs promotions on its website where visitors can win cash prizes by solving puzzles and being randomly chosen from correct entries. 
• Entrants are not required to make purchases to enter/win, nor are they required to perform any services to receive their prize.
• ALEX (age 15, a nonresident alien individual) wins a $1000 prize.

Issue 

• How much must COMPANY withhold in US income taxes from its $1000 prize payment to ALEX?

Short Answer

• COMPANY must withhold $300 in US taxes from ALEX's prize and send the remaining $700 to ALEX.

Brief Discussion

• Answer above is not intuitive.  ALEX does not have any obvious taxable connection to the US and solved the puzzle in his own home.
• COMPANY must determine the nature of the transaction taking place because it controls the “source” (i.e., US source vs. foreign source) of the income, which often dictates whether US income taxes must be withheld by the payor.
• Quick synopsis of US income tax withholding requirements (to the extent applicable here):
• Section 1441 applies to withholding of tax on nonresident aliens. It requires (among other things) that those having control over most types of income being paid to nonresidents withhold tax from those payments.
• Section 871 sets the tax rate (and thus the section 1441 withholding rate) at 30% on US source income of nonresident alien individuals.
• Source of income is mostly covered by sections 861 - 865. Key authorities relevant here:
• Section 861 – Compensation for services performed in the US are US source.
• Section 862 – Compensation for services performed outside of the US are foreign source.
• Section 863 – Permits Treasury to promulgate regulations as to source for items of income not specified in section 861 and 862.
• Treas. Reg. section 1.863-1(d)(2) provides that the source of income from prizes and awards is determined by the residence of the payor.
• ALEX winning the prize was not a direct result of solving the puzzle, it was a result of being chosen from all correct entries received by COMPANY.  As such, ALEX was not being compensated for services performed by him for COMPANY's benefit.  Thus, sections 861 and 862 do not apply to this issue.
• As a result, Treas. Reg. section 1.863-1(d)(2) treats ALEX’s prize as US source income because COMPANY (the payor) is a US person.
• Section 871 thus requires 30% withholding on the $1000 prize.
• If the person administering prize payments has (per section 1441) control over the payments, that person is a considered a “withholding agent” (defined under section 7701(a)(16)) and may be held responsible for the failure to withhold.

 Full text of Internal Revenue Code available at https://www.law.cornell.edu/uscode/text/26