NONRESIDENT ALIEN EMPLOYEES
Payroll Tax Guideline 104
Updated July 27, 2006
Scope - This guideline covers federal tax reporting and withholding requirements related to wage payments made by the University for services rendered by nonresident alien employees. Scholarships granted, and vendor payments made to nonresident aliens are covered by separate tax guidelines.
Background - Payments to nonresident alien employees are subject to unique tax withholding and reporting requirements. Although legal arguments may support a contrary position, the IRS generally takes the position that payments to nonresident alien employees must be reported to the employees and to the I.R.S. as follows:
- on Form W-2 (if no tax treaty applies),
- on Form 1042-S (if a tax treaty applies to all wages), or
- on both forms (if a tax treaty applies to some, but not all wages).
The nonresident alien must receive copies of these forms from the University to file a properly completed U.S. nonresident alien income tax return.
Tax withholding is generally required on wages to nonresident aliens unless one of approximately 57 U.S./foreign tax treaties applies. It is the responsibility of the nonresident alien to determine if a tax treaty applies and to prepare and submit certain tax forms regarding the tax treaty to the University. If the nonresident alien does not provide the tax forms, the University is required to withhold federal tax (see items II. and III. below).
Nonresident alien employees without a visa or with an improper visa classification are not authorized to work and should not be hired by the University. For example, "B-2" visa holders are in the U.S. for pleasure and are not authorized to work.
Nonresident Aliens Defined - For federal tax purposes, individuals are generally taxed as nonresident aliens if they do not fall into any of the following categories:
- United States Citizen,
- Individual with a Green Card, or
- Individual without a Green Card who meets the substantial presence test. The "substantial presence test" is generally satisfied if the individual was in the U.S. for at least 31 days in the current calendar year and if the individual was present in the U.S. for a total of 183 days (days counted towards the 183 day total include all days in the U.S. in the current year, 33.3% of the days in the U.S. in the 1st preceding year, and 16.7% of the days in the U.S. in the second preceding year).
Note - Students temporarily present in the U.S. on an F, J, M, or Q visa (for up to five calendar years) and teachers temporarily present on a J or Q visa (for up to two calendar years) are generally exempt from the substantial presence test and appear to constitute the vast majority of the University's nonresident aliens. A "calendar" year is the period from January 1 through December 31, not twelve consecutive months. If the individual is in the U.S. as an exempt individual for any part of a calendar year (e.g. as few as one day or as many as 365 days), that year will count as a full calendar year when determining the individual's exempt individual years.
U.S. Source Wages vs. Foreign Source Wages - The IRS tax reporting and withholding requirements only apply to U.S. source wages. Foreign source wages are not subject to U.S. tax law. In general, wages are sourced by reference to where the services are performed. In other words, U.S. source wages result from compensation earned with respect to services performed within the United States and foreign source wages result from services performed outside the United States.
I. Tax Reporting
Wages paid by the University to nonresident alien employees must be reported to the Internal Revenue Service., the Massachusetts Department of Revenue, and to the nonresident alien. Most wages are reported on Form W-2. Wages protected by tax treaty are reported on Form 1042-S.
II. Tax Withholding
Unless a tax treaty applies (see item III. below), federal tax withholding on wages paid to nonresident aliens generally is based on Form W-4 with the following attributes:
- single status (even if the nonresident alien is married),
- no more than one withholding allowance
In late December, 2005, the IRS released IRS Notice 2005-76 that changed the manner in which tax withholding on wages paid to nonresident alien employees is calculated. These new rules are designed to provide for withholding on the wages of a nonresident alien employee that more closely approximates the income tax liability of the non resident alien.
Effective for wages paid on or after January 1, 2006, IRS Notice 2005-76 significantly changes the manner by which employers calculate tax withholding for wages paid to nonresident alien employees for services performed in the U.S. It eliminates additional tax withheld per pay period and requires that an additional amount be added to the "taxable base" prior to calculating tax withholding. The Notice also requires employers to obtain new updated Forms W-4 from all nonresident alien employees.
Employers will be required, solely for Code Sec. 3402 withholding calculation purposes, to add new phantom amount to wages for given period. (Note: This procedure is not applicable for students and business apprentices from India.) The specific amount depends on the payroll period. Employers will determine the income tax to be withheld by applying the tables to the sum of the wages paid for the payroll period plus the additional amount. The added amount is not income or wages to the employee, does not affect income, FICA or FUTA tax liability for the employer or the employee, and is not to be reported as income or wages.
NRA employees will be required to complete new Form W-4 requesting withholding as if single, regardless of married status, and claiming no exemption and only 1 allowance. They must write "Nonresident Alien" or "NRA" above the dotted line after the words "Additional amount, if any, you want withheld from each paycheck" and before the box on line 6 of Form W-4. (Note: If the nonresident alien is a resident of Canada, Mexico, or South Korea, he or she may claim more than one allowance.)
This procedure is effective with respect to wages paid to nonresident alien employees on or after January 1, 2006. However, with respect to wages paid prior to January 1, 2007, the Internal Revenue Service will not assert an employer's liability for underpayments of income tax withholding and related interest and penalties resulting solely from the failure to apply the new withholding procedure to payments of wages made to nonresident alien employees, provided the employer has made a good faith effort to implement the withholding requirements in this notice as soon as possible. The transitional relief in the previous sentence does not affect the liability of employees for federal income tax.
The Withholding Agent should not collect new forms until such time as they can use the new calculation process as any new Forms W-4 must be honored within 30 days of collection.
The nonresident alien employee is not required to request additional withholding on the new Form W-4 however the employee may want to request additional withholding depending on their personal circumstances.
Note that the new rules are not applicable to a nonresident alien employee who is a student or business apprentice who is or was a resident of India immediately before visiting the United States and who is presently in the United States on an F-1 or J-1 Visa status.
There is a special exemption from FICA tax (including the Medicare payroll tax) for foreign employees who are (1) nonresident aliens for U.S. tax purposes, (2) present in the U.S. under F-1, J-1, M-1, or Q-1 visas, and (3) working in furtherance of the purpose of their visa. All three conditions must be satisfied. If a foreign employee does not meet any one of these conditions, they lose this special exemption and may become subject to FICA tax. Student employees may be eligible for another exemption from FICA (see Student Employee Payroll Tax Guideline 106).
University employees that are subject to FICA tax generally must have Medicare tax deducted from their wages and must be promptly enrolled in the mandatory Alternate Retirement Plan (Omnibus Budget Reconciliation Act of 1990 or "OBRA") or in the State Retirement Plan.
For 2006, the amount required to be added to the wages of a nonresident alien employee for purposes of calculating income tax withholding, for each length of payroll period is as follows:
|Daily or Miscellaneous (each day of the payroll period)
Updated tables are published each year in Publication 15. If intra-year changes in the tables are released, they may be in other IRS publications.
An Employer may not withhold a lesser amount than required by Code Sec. 3402 even if employee's tax liability may be less than required withholding because of alimony deduction.
III. Tax Treaties
A nonresident alien may claim that part or all of the wages are not subject to federal tax withholding because of treaty exemption. As of March 2006, the United States has entered into approximately 57 income tax treaties that affect 65 countries. Most treaties contain articles that specifically address tax benefits available to students studying in the other country. The treaties that provide for tax free wages, often contain restrictions on the annual amount (generally $2,000 to $5,000 per year), on the number of years the benefits are available, and on the employees' activities. Some treaties provide that nonresident teachers or researchers who temporarily visit the U.S. for the primary purpose of teaching or research are not subject to U.S. income tax on certain wages for the first several years after their arrival.
If the nonresident alien claims the payments are not subject to tax withholding because of treaty exemption, the following steps must be taken before any payments are made:
- Obtain Form 8233 and Instructions for Form 8233 for declaring exemption from withholding on compensation for services of a nonresident alien individual. It is the responsibility of the nonresident alien to inform the University of the specific basis for treaty exemption by completing and signing Form 8233 and any required attachments, each calendar year. Students and teachers are generally required to attach a signed activity statement. See the appendices of IRS Publication 519 for sample activity statements. If the nonresident alien does not provide a properly completed Form 8233, the University is required to withhold federal tax (see item II. above).
- Form 8233 must be reviewed by the University for completeness. The review should include examination of the relevant tax treaty articles. If the nonresident alien is eligible for treaty exemption, the properly completed Form 8233 and activity statement should be forwarded to the Campus Controller or Payroll Director for signature.
- Make three copies of the signed Form 8233. The original (along with the signed activity statement - if applicable) must be promptly mailed to the Internal Revenue Service International Office to the address specified on the Form. One copy must be given to the nonresident alien. The second copy along with the signed activity statement should be sent to the University Tax Manager at the end of the year to attach to Form 1042. The third copy of Form 8233 along with the signed activity statement should be retained in University files for seven years.
IV. References and Suggested Technical Resources
IRS Publication 513 - Tax Information for Visitors to the United States
IRS Publication 515 - Withholding of Tax on Nonresident Aliens and Foreign Entities
IRS Publication 519 - U.S. Tax Guide for Aliens
IRS Publication 520 - Scholarships and Fellowships
IRS Publication 901 - U.S. Tax Treaties
Note - Publications may be ordered at no charge by calling 1 (800) 829-3676 or can be accessed on the Internet through the IRS home page. Adobe Acrobat is necessary to read these files. You can download Adobe Acrobat by clicking here.
Nonresident Alien Tax Compliance - This book is authored by Donna Kepley and is published by Arctic International LLC. This soft cover book is an excellent guide for institutions like the University. It contains sample completed tax forms, and costs approximately $150. This book can be ordered by calling (202) 223-4583 or on-line at http://www.arcticintl.com.