Understanding International Taxpayers: U.S. Withholding and Tax Obligations

Introduction:

Navigating the U.S. tax system can be complex, particularly for international taxpayers. Here's a guide to help understand the key concepts and obligations for nonresident aliens and foreign entities as of 2024.

Nonresident Alien (NRA) Withholding

Nonresident alien (NRA) withholding applies to foreign persons, which include:

• Nonresident alien individuals: These are people who are not U.S. citizens or resident aliens. They are generally subject to withholding on income sourced from the United States.

• Foreign entities: This includes foreign corporations, partnerships, trusts, estates, and any entity that is not considered a U.S. person.

• Qualified intermediaries: Foreign branches of U.S. financial institutions may be treated as foreign persons if they are qualified intermediaries.

Who is a Nonresident Alien?

A nonresident alien is an individual who does not meet the criteria for being a U.S. citizen or resident alien. Residency status can be established through either:

• The Green Card Test: Holding a valid U.S. Permanent Resident Card (green card).

• The Substantial Presence Test: Being physically present in the U.S. for a significant amount of time during a calendar year.

Foreign individuals classified as residents under a tax treaty may also be considered nonresident aliens for withholding purposes.

Special Rules for Nonresident Aliens Married to U.S. Citizens or Residents

Nonresident aliens married to U.S. citizens or residents can elect to be treated as resident aliens for tax purposes. This election affects how their income is taxed, but they remain subject to NRA withholding rules on non-wage income. Wages are withheld according to the rules for U.S. citizens and residents.

Defining a U.S. Person

A U.S. person is defined as:

• A U.S. citizen or resident alien.

• A domestic partnership or corporation created or organized in the U.S.

• An estate or trust that is not classified as foreign.

Understanding U.S. Citizenship

A U.S. citizen can be:

• Born in the United States or its territories (Puerto Rico, Guam, U.S. Virgin Islands).

• Born to a U.S. citizen parent.

• A naturalized citizen.

Residents of U.S. Possessions

Individuals residing in U.S. possessions like the Northern Mariana Islands or American Samoa are treated as nonresident aliens for withholding purposes unless they are U.S. citizens. U.S. citizens born in these territories are considered U.S. persons.

Section 937 of the Internal Revenue Code outlines the requirements for individuals beginning or ending bona fide residency in U.S. possessions, including the need to file Form 8898. A $1,000 penalty may be imposed for failing to file this form.

Rules for Foreign Corporations

Foreign corporations are entities not organized in the U.S. Domestic corporations are those created under U.S. law or the laws of any state.

Guam and Northern Mariana Islands Corporations

Corporations formed in Guam or the Northern Mariana Islands are not considered foreign if:

• Less than 25% of the corporation's stock is owned by foreign persons.

• At least 20% of gross income is from sources within Guam or CNMI.

Virgin Islands and American Samoa Corporations

Corporations from the Virgin Islands or American Samoa are not foreign if:

• Less than 25% of stock is owned by foreign persons.

• At least 65% of gross income is connected to trade or business within the territories or the U.S.

• Income is not substantially used to meet obligations to non-residents of these areas.

Foreign Private Foundations

Foreign private foundations are subject to a 4% excise tax on gross investment income from U.S. sources, unless exempted by treaty. They must be distinguished from ordinary foreign tax-exempt organizations, which typically file Form W-8EXP to confirm their status.

Other Foreign Organizations

Foreign organizations exempt under section 501(a) do not generally have tax withheld on U.S. income unless identified as private foundations. These organizations should file Form 1042-S to report income, even if no tax is withheld.

U.S. Branches of Foreign Entities

Payments to U.S. branches of foreign entities are typically treated as payments to the foreign entity. However, U.S. branches of foreign banks and insurance companies can be treated as U.S. persons if specific agreements are documented with Form W-8IMY.

For more detailed information, consult IRS publications or seek professional tax advice to ensure compliance with current regulations.