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.
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