Foreign Nationals Are Still Responsible for U.S. Taxes
PMG Intrinsic represents non-U.S. citizen clients for their tax affairs. Often, they assume that they are not responsible for U.S. income tax. This assumption is wrong. A nonresident alien must pay taxes on any income earned in the United States to the IRS, unless the person can claim a tax treaty benefit. Usually, foreign nationals are subject to federal withholding tax on U.S. sourced income at a flat rate of 30%. Exemptions may apply if there is a tax treaty between the foreign national’s country of residence and the United States. The tax is generally withheld from the payment made to the foreign national.
Tax treaties are bilateral agreement between the U.S. and a foreign government. Tax treaties are intended to avoid having the income taxed by both countries. However, the terms of each treaty are different and include different exemptions. If a foreign national qualifies for an exemption because of a tax treaty benefit, the required withholding will be taken from the payment to the nonresident alien. However, the foreign national must have a U.S. tax identification number in order to claim the benefit.
However, clients are not finished with their tax analysis by withholding 30% of their income. Foreign nationals who lived in the U.S., must also complete the Substantial Presence Test. If the foreign national has been in the U.S. for “183 days” or more in the past three years, the individual is considered a resident alien for tax purposes. The IRS’ calculation of days is:
1. 31 days during the current year, and
2. 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
All the days you were present in the current year, and
1/3 of the days you were present in the first year before the current year, and
1/6 of the days you were present in the second year before the current year.
For example, one of PMG Intrinsic’s clients was in California for 120 days in 2019, 80 days in 2018, and 45 days in 2017. Based on the Substantial Presence Test, he had a total of 154 days, calculated as:
120 days in 2019;
26 days in 2018; and
8 days in 2017.
A client is treated as present in the U.S. on any day physically present in the country, at any time during the day. However, there are exceptions to this rule. When a client meets the Substantial Presence Test, he is considered a resident alien and cannot avail himself of any tax treaties. However, he may utilize other provisions in the tax code that may provide substantial tax planning, and entity structuring benefits previously unavailable to nonresident aliens, such as the ability to form S corporations.