U.S. Income Tax (Non-Resident Aliens)
Non-resident liens are subject to U.S. Income Tax on U.S. source: (1) FDAP Income, (2) Effectively Connected Income.
(1) “FDAP” Income
U.S. Source “FDAP Income” i.e., Fixed or Determinable Annual or Periodical Income (e.g., salaries, wages, interest, rents, dividends and royalties).
A non-resident alien is subject to U.S. federal income tax on FDAP income at a flat 30% tax rate (without the benefit of any related deductions) IRC §871(a), 873(a). The flat 30% income tax is withheld at the income source (IRC §1441).
“FDAP Income” includes:
1. Gains from sale of intangible property (i.e., patents, copyrights or other intangibles) (IRC §871(a)(1)(D).
“FDAP Income” does not include:
1. Gain from the sale of stock of a domestic corporation (Treas Reg §1.871-7(a)(1)).
2. Interest on bank deposits and “portfolio interest” (IRC §871(h) and (i).
Income tax treaties may reduce or eliminate the 30% flat tax on the FDAP Income.
(2) Effectively Connected Income
Income that is “effectively connected” to a U.S. trade or business.
A non-resident alien, who is engaged in a U.S. trade or business, is subject to U.S. federal income tax on his “effectively connected income”, at same tax rates as U.S. citizens and resident aliens (IRC §871(b)).
For a non-resident alien, engaging in a U.S. trade or business is not the basis for U.S. income tax. U.S. income tax is imposed if a non-resident alien owns a business through a permanent establishment in the U.S., i.e., a fixed place of business, (e.g., place of management, a branch, an office, a factory).
If the non-resident alien is a resident of a country with which the U.S. has an income tax treaty, the treaty may reduce or eliminate U.S. federal income tax on effectively connected income.
A non-resident alien must file IRS Form 8833 to disclose reliance on a U.S. tax treaty for an exemption from U.S. tax on “effectively connected income.”
U.S. Estate Tax (Non-Resident Aliens)
A non-resident alien is subject to U.S. estate tax on their taxable estate assets situated in the U.S. (IRC §2101(a), 2106(a)).
For U.S. estate tax, both stock of a U.S. corporation (IRC §2104) and U.S. real estate (Treas Reg §20.2104-1(a)91)) are “situated” in the U.S.
Non-resident aliens are entitled to:
1. Unlimited deduction for transfers to U.S. citizen spouses (IRC §2106(a)(3)).
2. A “$60,000 unified credit”, which permits a non-resident alien to transfer only $60,000 worth of property free of estate tax.
3. Deduct a portion of expenses, indebtedness, taxes and losses from their gross estates (IRC §2106(a)(1)), deduct certain charitable contributions from their gross estates (IRC §2106(a)(2)(A)), but only if they disclose their world-wide estate in their estate tax return (IRC §2106(b)).
A person who acquires property from a non-resident alien decedent will receive a “stepped-up” basis in the property (i.e., a basis equal to the fair market value of the property at the date of the decedent’s death) regardless of whether the property was includible in the non-resident alien’s gross estate for estate tax purposes (IRC §1014(b)).
Generation Skipping Tax
Non-resident aliens are subject to the generation skipping tax but only on gifts subject to gift or estate tax (e.g., no gift tax on lifetime “skips” of intangible property).
U.S. Gift Tax (Non-Resident Aliens)
A non-resident alien is subject to gift tax when he makes a gift of real or tangible personal property situated in the U.S. (IRC §2501(a)(1), §2511(a); Treas Reg §25.2511-1(b)).
A gift of U.S. real estate is subject to gift tax (Treas Reg §25.2511-3(b)(1).
A gift of U.S. intangible personal property is not subject to gift tax (IRC §2501(a)(2).
Non-resident aliens are not entitled to the unified credit ($1M in gifts exempt from tax).
Non-resident aliens are entitled to:
1. $13,000 annual exclusion for gifts to any person.
2. Unlimited exclusion for gifts to defray educational or medical expenses.
3. The unlimited exclusion for gifts to citizen spouses.
4. The $133,000 (2009) annual exclusion for gifts to non-citizen spouses (see: Rev Proc 2008-66, IRC §2503(b); 2503 (e), Treas Reg §25.2523(i)-(1)(a), (c)(2)).
5. Unlimited amount of property to U.S. charity free of gift tax (IRC §2522(b)).
6. Unlimited amount of property to a trust, or foundation, only if the gift is to be used within the U.S.
7. Basis of property, acquired by gift from a non-resident alien is determined in the same manner as property basis acquired by gift from a resident alien (IRC §1015, 1015(d)).
U.S. Income Tax Treaties
Under U.S. Federal Income Tax Laws, an alien is either taxed as a resident alien (subject to U.S. Income Tax on world-wide income) or a non-resident alien (subject to U.S. Income Tax on U.S. source income).
Non-Resident Alien: U.S. Tax Resident
An alien is classified as a resident alien (U.S. tax resident) if:
1. He is a U.S. lawful permanent resident at any time during the calendar year (i.e., has a “green card”).
2. He meets the “substantial presence test” (present in the U.S. for 122 days per year over a 3 year period).
Substantial Presence Test
An alien satisfies the “substantial presence test” for any calendar year (the “current year”) if:
1. He is in the U.S. for at least 31 days during the current year.
2. The sum of the number of days in the U.S. in the current year and two preceding calendar years equals or exceeds 183 days (“183 day test”).
3. For the “183 day test”, each day in the U.S. in the current year is counted as a full day. Each day in the U.S. in the first preceding calendar year is counted as 1/3 of a day, each day of presence in the second preceding calendar year is counted as 1/6 of a day (IRC §7701(b)(3)(A)(ii)).
“Substantial Presence Test”: Closer Connection Exception
An alien who meets the substantial presence test may avoid being classified as a U.S. tax resident if:
1. He is present in the U.S. for fewer than 183 days during the calendar year.
2. He maintains a tax home in a foreign country during the entire current year.
3. He has a closer connection to the foreign country (i.e., his tax home) during the current tax year.
4. He timely files IRS form 8840, and has not applied for a “green card” (IRC §7701(b)(3)(B) and (C)).
The United States has 61 income tax treaties (see below). To be eligible for the benefits of an income tax treaty, an individual must qualify as a resident of either the U.S. or the other country that is a party to the treaty (“the contracting state”).
The U.S. Model Income Tax Treaty (Art 4(1)) defines “resident of a contracting state” as “any person who, under the laws of that state is liable for tax in the state, by reason of his domicile, residence, citizenship, place of management, place of incorporation”.
If an alien is classified as both a U.S. tax resident and a resident of its treaty partner (“dual resident”), the tax treaties contain “tie-breaker” provisions which determine the dual resident’s tax residence status as follows:
1. Tax resident in country with permanent home.
2. If permanent home in both countries, tax resident in country with “center of vital interests” (personal and economic interests).
3. If the center of vital interests cannot be determined, tax resident in country in which he has a habitual abode.
4. If the habitual abode is in both (or neither) countries, he is a tax resident of the country in which he is a national).
An alien who claims the benefit of a treaty, to be classified as a non-resident, will still be subject to U.S. federal income tax as a non-resident alien.
A non-resident alien who relies on a U.S. tax treaty for an exemption from U.S. tax that is effectively connected with a U.S. trade or business is required to file IRS Form 8833 to disclose the tax exemption reliance (IRC §6114; Treas Reg 301.6114-1).
U.S. Income Tax Treaties
1. Australia Income Tax Treaty
2. Austria Income Tax Treaty
3. Bangladesh Income Tax Treaty
4. Barbados Income Tax Treaty
5. Belgium Income Tax Treaty
6. Bermuda Income Tax Treaty
7. Bulgaria Income Tax Treaty
8. Canada Income Tax Treaty
9. China Income Tax Treaty
10. Cyprus Income Tax Treaty
11. Czech Republic Income Tax Treaty
12. Denmark Income Tax Treaty
13. Egypt Income Tax Treaty
14. Estonia Income Tax Treaty
15. Finland Income Tax Treaty
16. France Income Tax Treaty
17. Germany Income Tax Treaty
18. Ghana Income Tax Treaty (Ships and Aircraft)
19. Greece Income Tax Treaty
20. Hungary Income Tax Treaty
21. Iceland Income Tax Treaty
22. India Income Tax Treaty
23. Indonesia Income Tax Treaty
24. Ireland Income Tax Treaty
25. Israel Income Tax Treaty
26. Italy Income Tax Treaty
27. Jamaica Income Tax Treaty
28. Japan Income Tax Treaty
29. Jordan Income Tax Treaty (Shipping and Aircraft)
30. Kazakhstan Income Tax Treaty
31. Korea Income Tax Treaty
32. Latvia Income Tax Treaty
33. Lithuania Income Tax Treaty
34. Luxembourg Income Tax Treaty
35. Malta Income Tax Treaty
36. Mexico Income Tax Treaty
37. Morocco Income Tax Treaty
38. Netherlands Income Tax Treaty
39. New Zealand Income Tax Treaty
40. Norway Income and Property Tax Treaty
41. Pakistan Income Tax Treaty
42. Philippines Income Tax Treaty
43. Poland Income Tax Treaty
44. Portugal Income Tax Treaty
45. Romania Income Tax Treaty
46. Russia Income Tax Treaty
47. Slovak Republic Income Tax Treaty
48. Slovenia Income Tax Treaty
49. South Africa Income Tax Treaty
50. Spain Income Tax Treaty
51. Sri Lanka Income Tax Treaty
52. Sweden Income Tax Treaty
53. Switzerland Income Tax Treaty
54. Thailand Income Tax Treaty
55. Trinidad and Tobago Income Tax Treaty
56. Tunisia Income Tax Treaty
57. Turkey Income Tax Treaty
58. Ukraine Income Tax Treaty
59. United Kingdom Income Tax Treaty
60. USSR Income Tax Treaty
61. Venezuela Income Tax Treaty
U.S. Estate and Gift Tax Treaties
Under U.S. Federal Estate & Gift Tax Laws, an alien is taxed as a U.S. Estate & Gift Tax Resident once he establishes a U.S. domicile. An alien acquires a U.S. domicile by living in the U.S. (for even a brief period of time) with the requisite intention to indefinitely remain (Treas Reg §20.0 – 1 (b)(1) Treas Reg §25.2501 – 1(b))
An alien, who establishes a U.S. domicile, is subject to:
1. A U.S. Gift tax on the donor’s act of making the gift (transfer of asset) (IRC §2501(a))
2. A U.S. Estate tax on the transfer of their taxable estate (worldwide assets) (IRC §2001(a))
Since 1976, a unified tax rate is applied to assets transferred for both estate and gift tax (tax free gifts up to $1M, tax free estate up to $3.5M (2009), which includes gifts).
Top Tax Rate (2009): 45%
The United States has 18 estate & gift tax treaties (see below). To qualify for the treaty tax benefits, an alien must be domiciled in either the U.S. or a U.S. Treaty Country i.e., country of origin (or choice), at the time of his death or at the time of the gift.
The treaties contain special tax rules which may reduce the alien’s U.S. Federal estate and gift tax liability. The treaties are designed to prevent double taxation on the transfer of the same asset (which is the subject of the estate or gift tax).
1. Australia Estate Tax Treaty
2. Australia Gift Tax Treaty
3. Austria Estate and Gift Tax Treaty
4. Canada Estate Tax Treaty
5. Denmark Estate and Gift Tax Treaty
6. Finland Estate Tax Treaty
7. France Estate and Gift Tax Treaty
8. Germany Estate and Gift Tax Treaty
9. Greece Estate Tax Treaty
10. Ireland Estate Tax Treaty
11. Italy Estate Tax Treaty
12. Japan Estate and Gift Tax Treaty
13. Netherlands Estate Tax Treaty
14. Norway Estate and Inheritance Tax Treaty
15. South Africa Estate Tax Treaty
16. Sweden Estate, Inheritance and Gift Tax Treaty
17. Switzerland Estate and Inheritance Tax Treaty
18. United Kingdom Estate and Gift Tax Treaty
Translator
By N2H
