The American Payroll Association contributed the article below to the SSA/IRS Reporter newsletter.
Taxation of International Students – Are You Making the Grade?
As temperatures start to drop and the leaves begin to change, you may notice parents cheering and children lamenting as another school year commences. This exciting time not only affects American teachers and students, but extends to foreign students and scholars traveling to America in search of education and learning opportunities. However, these individuals who are temporarily present in the United States as students, trainees, scholars, teachers, researchers, exchange visitors, and cultural exchange visitors are subject to special rules with respect to the taxation of their income.
Resident vs. nonresident alien
The taxation and reporting of income earned by foreign citizens (aliens) working in the United States depends on whether the employee is a resident or nonresident alien. In general, resident aliens are taxed on their worldwide income and their employers treat them the same way they treat U.S. citizens.
Nonresident aliens, however, are taxed only on their income from U.S. sources, with some exceptions. Nonresident aliens are subject to the same federal income tax withholding requirements as other employees for all of their income that is from U.S. sources. To accomplish this, employers must obtain each nonresident alien employee’s social security number and have the employee complete a Form W-4, Employee’s Withholding Allowance Certificate. Wages paid to and taxes withheld from nonresident alien employees must be deposited and reported by the employer the same way it does for all other employees, on Forms 941 and W-2. The employer must also retain a completed Form I-9, Employment Eligibility Verification, attesting to the employee’s identity and authorization to work in the United States.
Special instructions for Form W-4
Just like any other employee, a nonresident alien should give the employer a valid, completed Form W-4 so the employer can determine how much federal income tax to withhold. However, there are special instructions that must be followed (rather than those appearing on the Form W-4) because of certain restrictions nonresident aliens face regarding their filing status, number of allowances, and inability to claim the standard deduction on their personal tax returns.
• Line 2. Nonresident aliens must enter a social security number on Line 2. If they don’t have one, they need to apply for one on Form SS-5, Application for a Social Security Card. They cannot enter an Individual Taxpayer Identification Number (ITIN) on Line 2.
• Line 3. Nonresident aliens must request withholding as if they are single, regardless of their actual marital status.
• Line 5. Nonresident aliens can claim only one withholding allowance on Line 5 unless they are residents of Canada, Mexico, South Korea, or are U.S. nationals. Students and business apprentices from India may also claim additional allowances under certain circumstances.
• Line 6. Nonresident aliens must write “Nonresident Alien” or “NRA” above the dotted line on Line 6.
• Line 7. Nonresident aliens cannot claim ”Exempt” withholding status on Line 7.
Employers must follow a two-step process when withholding federal income tax from the wages of nonresident alien employees.
• Step 1. Add the amount listed in Publication 15 (Circular E), Employer’s Tax Guide, corresponding to the employee’s payroll period (e.g., weekly, biweekly, semimonthly, etc.) to the nonresident alien employee’s wages for that payroll period.
• Step 2. Use the amount calculated in Step 1 to figure out income tax withholding using the tables that are used to figure income tax withholding for all other employees.
Social security and medicare taxes
Amounts earned by nonresident aliens as students, scholars, or exchange visitors under an F, J, M, or Q visa are not subject to social security or Medicare tax if the work they perform is carried out to further the purpose for which they entered the United States. The exemption does not extend to the spouse or children of such nonresident aliens, who may be admitted under a derivative visa.
Scholarships and fellowships granted to nonresident alien students are exempt from social security and Medicare taxes to the same extent they are exempt from federal income tax withholding.
Federal unemployment tax
In general, federal unemployment (FUTA) tax applies to all wages paid for work performed in the United States, regardless of the citizenship or residency status of the employee or employer. This is true for nonresident aliens even though the employee may be exempt from federal income tax. The exemptions from FUTA for wages received and work performed by nonresident aliens in the United States are the same as those applicable to social security and Medicare taxes, although there are no international agreements exempting temporary employment by a nonresident alien in the United States.
Foreign students receiving scholarships or fellowships
Scholarships and fellowships granted to nonresident alien students to cover tuition and related expenses (e.g., fees, books, supplies, and required equipment) are exempt from federal income tax withholding and reporting if the students are degree candidates and are temporarily in the United States as nonimmigrants under F, J, M, or Q visas. Payments that do not qualify for the exemption because they are unrelated to tuition (e.g., food, lodging, etc.) are subject to withholding at a rate of 14 percent.
If the nonresident alien student receiving scholarship or fellowship money is not a degree candidate, the payments are included in income and are subject to federal income tax withholding of 14 percent if the grantor is listed below. If the payment is not from a grantor listed below, the withholding rate is 30 percent.
• a tax-exempt organization under Code Sec. 501(c)(3);
• a federal, state, or local government agency;
• a foreign government;
• an international organization
• a binational or multinational educational or cultural foundation or commission created under the Mutual Educational and Cultural Exchange Act of 1961.
If a nonresident alien student receiving a scholarship or fellowship is required to perform teaching, research, or other work as a condition of receiving the scholarship, the student is receiving gross income unless all candidates for the same degree are required to do the same work. The income is determined by reference to payments made for similar work to individuals who are not receiving a scholarship or fellowship and is subject to withholding at regular rates. (SSA/IRS Reporter Fall 2014 (IRS Pub 1693, October 2014.)
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