Monday, December 6, 2010

Individual Taxpayer Identification Number

Tax Implications on Certain Immigrants and Non-Immigrants

Many believe that if they do not have a social security number, they are exempt from taxation. The ITIN (Individual Taxpayer Identification Number) is a 9-digit tax processing number issued by the IRS. ITIN’s are issued regardless of immigration status because both resident and non-resident aliens may have U.S. tax return and payment responsibilities under the Internal Revenue Code. ITIN’s do not authorize work in the U.S. or provide eligibility for social security benefits. An original passport is one of the 13 types of documents that are acceptable proof of identity and foreign status.

IRS Publication 1915 states the following question: “Can I get an ITIN if I am an undocumented alien?” And it gives the answer: “Yes, if you are required to file a U.S. federal income tax return or qualify to be listed on another individual’s tax return, you must have either a valid social security number or an ITIN. If you are an undocumented alien and cannot get a social security number, you must get an ITIN for tax purposes.”

Resident Alien
An individual who is not a U.S. citizen is classified as a resident alien if he meets 1)the lawful permanent resident test, 2)the substantial presence test, or 3)elects to be treated as a resident. The substantial presence test uses a complicated formula under which the individual is treated as a resident alien if they are present in the U.S. a) for at least 31 days during the current year, and b) for a total of 183 adjusted days under the formula.

Non-Resident Alien
On the other hand, income of a non-resident alien that is not effectively connected with the conduct of a U.S. trade or business is generally exempt from U.S. income tax unless it is from sources within the U.S. and falls within the definition of “fixed or determinable annual or periodical gains, profits, and income” (otherwise known as “FDAP”). FDAP includes wages and compensation, interest, dividends, rents and royalties received from U.S. sources, but does not include capital gains and other income realized from the sale of property. The tax on FDAP is applied at a flat rate of 30 percent and is usually collected by the payor of income who withholds this tax from the nonresident alien and remits the tax to the IRS. No deductions are allowed in arriving at the taxable amount.

Salaries, wages and compensation from U.S. sources are included in FDAP and these payments are subject to either (i) the 30 percent withholding tax, or (ii) wage withholding on the same basis as U.S. citizens and residents. Wages, salaries and compensation are U.S. source if such payments relate to services performed in the U.S. However, if such compensation does not exceed $3,000 for a tax year the income is treated as foreign source, and not subject to withholding, if (1) the nonresident is temporarily present in the U.S.; (2) the nonresident is not present in the U.S. for more than 90 days during the tax year; and (3) the employer is either a foreign person not engaged in business in the U.S., or is a foreign office of a U.S. employer. Most students will fail to qualify for this exemption. Still, because the performance of services in the U.S. generally gives rise to the existence of a U.S. trade or business (and because nonresident student aliens holding F, J or M visas are always considered engaged in a U.S. trade or business), payments for such services are often not subject to the withholding tax and are instead taxed under the effectively connected income rules.

Income of a nonresident alien that is effectively connected with the conduct of a U.S. trade or business (otherwise known as “effectively connected income” or “ECI”) is subject to taxation on a “net basis,” meaning that the nonresident may take into consideration certain allowable deductions when computing taxable income. Additionally, tax is payable following the close of the tax year at normal, graduated tax rates.
Items ordinarily included in FDAP are instead treated as ECI if one of two tests is satisfied. The first test is satisfied if the FDAP type income arises from assets used or held in the conduct of the U.S. business. The second test is satisfied if the activities of the U.S. trade or business were a material factor in producing such income.

The U.S. has income tax treaties in effect with many countries. If you are a resident or citizen of such a country you may qualify for certain benefits that reduce or eliminate the need to withhold income or employment taxes.

Foreign Students
When determining the impact of U.S. income taxes on a foreign student, the analysis always begins with determining whether a student is a “resident alien” or “non-resident alien” for tax purposes.

Since most school years start in August or September, most foreign students will likely not meet the substantial presence test above during their first year. Also, there is an exemption to the substantial presence test for students. A special form needs to be filed with the IRS to verify this exemption. If a person is determined to have violated their F, J, or M visa according to the IRS, they can lose this exemption. There are several exceptions to this exemption, so please call us at 281-340-2074 with any questions.

Taxable scholarships and grants received by nonresident aliens are subject to the withholding tax if the payor of the scholarship or grant resides in the U.S.; however, the rate of tax is reduced to 14 percent. Generally, scholarships and grants are taxable to the extent not used for qualified expenses, which include tuition and fees required to enroll in school. Therefore, amounts used for living expenses are generally taxable. To the extent a scholarship or grant is provided by your educational institution, the school may actually withhold tax from that portion of the scholarship or grant payable towards expenses such as room and board. Ordinarily, nonresident students admitted to the U.S. under F, J or M visas that receive income from wages, tips, scholarships and grants are subject to tax as if such income is ECI.

Foreign students who are treated as resident aliens are taxed on their worldwide incomes in a manner identical to that of U.S. citizens. Annual income tax returns must be completed and income tax should be paid to the U.S. government.

In Summary
Non-Citizens with U.S. source income should always consider consulting with a qualified tax professional as the tax rules affecting these groups is unfortunately very complex.

Rehan Alimohammad is an Attorney and CPA.  Our office handles all tax law and immigration law issues.  In the past year we have successfully trained over 200 people, including Attorneys, CPA’s, and Enrolled Agents, on how to successfully resolve cases with the IRS and State Tax Agencies.  Please visit our website at, or call our offices at (281) 340-2074 or (800) 814-3920.

Disclaimer:  This article is not meant as specific advice regarding a person’s individual case.  An attorney should be consulted.  This article does not create an Attorney-Client relationship.   Any tax information or written tax advice contained herein (including any attachments) is not intended to be and cannot be used by any taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer.  (The foregoing legend has been affixed pursuant to U.S. Treasury Regulations governing tax practice.)

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