Current legislation regarding foreign tax issues can be daunting. In recent years, IRS scrutiny regarding all things foreign has reached new levels of disclosures, some of which have been extremely burdensome to taxpayers. Tax professionals start throwing around terms like FATCA, FBAR, PFIC, and tax treaty and it may feel like this is a world you do not wish to enter. Things are made even more intimidating by the minimum $10,000 penalty associated with some of these filings. On the subject of hiring foreign nationals, we hope to clarify the necessary steps and show that it need not be overwhelming.
In Part 1, we addressed some current issues surrounding different visa programs and highlighted some of the different visa options that might be available to your organization. In Part 2, we will consider the filing and withholding requirements for your organization. We encourage you to consult your tax or legal advisor before making a final determination regarding your filing and withholding requirements.
Filing and Withholding Requirements
This is the category that, as tax advisors, we get very excited about. We need to look at two overlapping issues. First, is your employee a nonresident alien or a resident alien? Second, which forms and withholding requirements concern you as the employer? The second question is often much murkier due to the complexities involved.
Resident and Nonresident Aliens
Resident aliens are taxed on the same basis as a U.S. citizen, on their worldwide income. Nonresident aliens are taxed only on income from U.S. sources. Nonresident aliens have interesting implications from a tax and withholding perspective.
Resident aliens must pass one of two basic tests. The first test is the “lawful permanent resident” test. If the individual holds an alien registration card (commonly referred to as a green card), then the individual is a resident alien. Once the green card is received, residency is said to begin the first day they are present in the U.S. with the green card. The second test is the substantial presence test. While there is more to the test than stated here, in general, you should look into this test if the foreign national is physically present in the U.S. for at least 183 days during a three-year period.Nonresident aliens are any foreign nationals that do not pass either of the two previously mentioned tests. Once you have determined which category your employee falls into, we can move to the more complex issue of forms and withholding requirements.
Forms and Withholding Requirements
Be aware that salaries and wages, stipends, housing or food may have different filing requirements and tax implications. Salaries and wages are the most obvious form of compensation. For a resident alien, the organization will treat the employee as a U.S. resident with the same types of withholding as other employees who are U.S. residents, alien or not.
The taxability of a nonresident alien may be governed by a tax treaty. One of the benefits of a tax treaty is that it may allow residents of foreign countries to be taxed at reduced rates or to be exempt from U.S. income tax on certain items of income. Under these same treaties, residents of the U.S. receive the same reciprocal benefit from the treaty country. (Be aware that not all countries – for example, many African and South American countries – have tax treaties with the U.S.)
One of the biggest concerns in this area is withholding under sections 1441, 1442, and 1443 of the Internal Revenue Code. If a nonresident alien is from a country without a tax treaty or is not eligible for treaty benefits, then withholding at the rate of 30% is required and it is the responsibility of the employer paying the wages to withhold. The tax treaties are available on the IRS website. IRS Publication 901 also provides a brief outline.
When a tax treaty is applicable, the following forms may need to be filed to garner the specified benefit:
- Form 8233, Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual,
- A separate Form 8233 needs to be filed for each tax year, each withholding agent, and each type of income.
- Form 1042, Withholding on Payments of U.S. Source Income to Foreign Persons,
- Wages that were paid to a nonresident alien should be reported on this form regardless of whether withholding of income tax was required.
- Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding,
- Wages that were paid to a nonresident alien with tax withholding under a tax treaty will be reported on a Form 1042 and Form 1042-S
- Form 1042-S reports all non-employee compensation payments (such as independent contractor payments, honoraria, royalties, and awards)
- Form 1042-S includes income commonly known as FDAP, i.e. fixed, determinable, annual or periodical. FDAP income commonly includes most interest, dividends, rents, royalties, and annuities.
- For any treaty-based position, other than withholding, a Form 8833, Treaty- Based Return Position Disclosure, will be required with the tax return that is filed.
Be aware that if all wages are exempt under a tax treaty, a Form W-2 should still be filed to report the state and local wage amounts and state and local income tax withholdings. Also, if the nonresident alien is a foreign student holding an F-1 or J-1 visa, the majority of these visa holders are exempt from FICA and Medicare tax withholding.
When there is no tax treaty that is applicable, the filing requirements are clearer, though not as beneficial for the taxpayer or the employer.
- Form W-4, Employee’s Withholding Allowance Certificate,
- If you are not claiming a tax treaty withholding exemption, then a Form W-4 must be filed for any compensation for which you are not claiming a tax treaty exemption.
- A nonresident alien may only claim the “single” filing status, regardless of whether or not they are married.
- Form W-2, Wage and Tax Statement,
- This will be required for any compensation paid to a nonresident alien without a tax treaty. Any additional compensation over the tax-exempt amount should be reported on a Form W-2 in the normal manner.
- Form 1042, Withholding on Payments of U.S. Source Income to Foreign Persons,
- Wages that were paid to a nonresident alien should be reported on this form if they were reported on a Form W-2.
Other exemptions from withholding from nonresident aliens may apply if the nonresident alien is in the U.S. for 90 days or less in a taxable year, if compensation for services does not exceed the current $3,000 personal exemption, and if the nonresident alien is performing the services as an employee or under contract with another nonresident alien individual or a foreign entity not engaged in trade or business in the U.S. As you can see, this last exemption is fairly strict and not applicable to U.S. organizations looking to hire foreign nationals. This may be applicable to meeting participants coming to the U.S. In this instance, nothing needs to be filed by the U.S. organization.
Stipends can be another form of compensation and are most commonly associated with government or non-profit entities. These payments are made to individuals to cover certain living expenses. Providing housing or food for anything beyond the convenience of the employer may be considered compensation.
As an employer you must be careful to make the proper determination regarding whether or not the stipend is includable in the individual’s gross income. If the stipend is provided in return for services, it is generally includable. If it is for participation in a training program that promotes general welfare, then it may not be gross income. Examples include stipends to aid the participants in acquiring training skills to improve opportunities for gainful employment.
Once it is determined whether or not the stipend is compensation, the organization should determine whether the individual is an employee or independent contractor so that proper documentation, withholding, and filings can be made.
As previously addressed, there has been a recent push for offshore disclosure by the Internal Revenue Service. It is important to remember that the organization as well as employees may have supplemental filing requirements for assets held abroad. These may include Form TDF 90-22.1, Report of Foreign Bank and Financial Accounts, as well as the Form 8938, Statement of Specified Foreign Financial Assets. The penalties for noncompliance in this area are severe and, unless the organization qualifies under a voluntary disclosure program, may be set at a minimum of $10,000 per filing for late or delinquent disclosure.
Hiring foreign nationals and dealing with visa applications and the various filing and withholding requirements are not simple. There are areas, such as student visa applications, where organizations are ready and willing to bear a majority of the administrative burden. Anything outside of these student visa applications will require more involvement and effort by the hiring organization. With good advisors, hiring foreign nationals can be broken down into workable chunks and the process is much more navigable. With increased awareness and an eye to current issues there can be many benefits.
As more organizations seek to improve their international reach or to broaden the perspectives it will become even more essential to have this basic knowledge regarding the requirements. In the nonprofit world, it is important to recall the benefits of these foreign hires and realize that there are advisors who can help you navigate.