Bar News - February 17, 2016
Tax Law: Immigration and Taxes: Who Has to Pay US Income Tax?
By: Michelle Radie-Coffin
The United States taxes the worldwide income of US citizens, regardless of where they reside or are domiciled. This means if you are a US citizen residing in another country and earning income from a business you are conducting in that country, the United States has the jurisdictional authority to tax your income earned from that other country solely because you are a US citizen.
Individuals who meet the definition of “resident alien” under the Internal Revenue Code (IRC) are deemed to be US citizens for tax purposes and are taxed on worldwide income. In general, they are subject to the same US tax treatment as US citizens.
Under the current law, an individual is a “resident alien” if he or she passes the “green card” test, or the “substantial presence” test. Under Section 7701(b) of the IRC, a resident alien is defined as an individual who is a permanent resident of the United States under the immigration laws (the so-called green card test) or any alien who meets the “substantial presence” test. The substantial presence test is a formula intended to identify aliens who spend substantial periods of time in the United States. The test will be met if the alien was present in the United States during the tax year on at least 31 days and was present within the United States for 183 days during the tax year and the two preceding years, as determined under the following formula:
||one day is one day
|1st preceding year
||one day is 1/3 of a day
|2nd preceding year
||one day is 1/6 of a day
Section 7701(b)(5) defines certain “exempt” individuals. Individuals under this exempt category do not have to count the days present in the United States (subject to certain limitations). For instance, a foreign student in the United States on an F or M visa is an exempt individual for a period of five calendar years. In addition, the substantial presence test does not count days of presence of an individual who is physically unable to leave the United States because of a medical condition that arose while the individual was present in the United States. (See IRC Section 7701(b)(3)(D)(ii).)
It is important to remember that lawful permanent residents (LPRs), also known as “green card holders,” do not use the substantial presence test. A person with a green card is automatically classified as a United States tax resident and must report all of his or her income, whether earned abroad or domestically. He or she might not step foot in the United States all year, but must still report all income to the IRS.
The number of days the person spends in the United States, counting toward residency for US tax purposes, is used for individuals who are present in the United States on a temporary basis. This includes those holding nonimmigrant visas, such as a foreign employee working in the US on an H-1B visa. It is important to note the distinction. An individual with a green card is an immigrant and deemed a permanent resident and taxed just like a US citizen. A person holding a nonimmigrant visa is here temporarily and not deemed a resident for tax purposes, unless that individual meets the substantial presence test.
Both green card holders (immigrants) and those who meet the substantial presence test (nonimmigrants) must file an IRS Form 1040 each year by April 15. If a green card holder fails to file, it may hurt their chances of becoming a US citizen upon applying for such status. Additionally, if a green card holder intentionally fails to file their taxes, they may be guilty of a crime, which could result in the loss of their green card and deportation.
Implications for Foreign
The focus up to this point has been on foreign individuals, but what about the US tax implications on foreign corporations? Any corporation not organized under the laws of the United States, any state, or the District of Columbia is a “foreign corporation” under current law, regardless of the location of the head office or place of management. (See IRC Section 7701(a)(5).)
Like US citizens and resident aliens, US corporations are subject to US taxation on worldwide income. The jurisdictional basis is again the nationality principle. Like foreign persons (nonresident aliens), foreign corporations are subject to two different taxing regimes. One regime applies to income that is effectively connected to a trade or business within the United States. The other regime applies to certain specified types of passive income from US sources. The latter regime generally relates to passive-earned income, such as interest, dividends, rents, and royalties.
If a foreign corporation conducts a trade or business in the United States, the net income effectively connected with the US business activity will be taxed at the usual US rates. (See IRC Sections 871(b) and 882.) If a foreign corporation received US source income in respect of investments not effectively connected to a trade or business within the United States (such as dividends, interest, rents or royalties), the gross amount of the payment generally will be subject to a tax of 30 percent. (See IRC Sections 871(a) and 881(a).)
This US tax on a foreign person’s (individual and corporation) nonbusiness income from US sources is collected and enforced through withholding provisions, which require the payor of the income to withhold the 30 percent tax from the income, and pay it over to the US Treasury, for the account of the foreign individual or corporation. (See IRC Sections 1441 and 1442.)
Finally, no analysis of the implications of tax on foreign taxpayers would be complete without mention of the role of income tax treaties. Section 894(a)(1) of the IRC states that the provisions of the code “shall be applied to any taxpayer with due regard to any treaty obligation of the United States which applies to such taxpayer.” The United States has income tax treaties with a number of foreign countries.
These treaties may provide for reduced income tax rates and exemptions. Generally, the terms of the treaties vary among countries and specific types of income. If a treaty does not cover a particular kind of income, or if there is no treaty between the intended taxpayer’s country and the United States, the taxpayer must pay tax on the income in the same way and at the same rate as a US citizen would, subject to certain limitations.
Michelle Radie-Coffin is an attorney at Shaheen & Gordon. Her practice focuses on immigration, tax, business and employment law.