In 1913, the Sixteenth Amendment to the U.S. Constitution was ratified. It empowered Congress to tax incomes from whatever source derived. While some states do not have an income tax (Nevada, Florida, etc.), all residents and all citizens of the United States are subject to the federal income tax. Not everyone, however, must file a return.

All nonresident aliens engaged in U.S. trade or business must file a U.S. income tax return even if their income didn't come from U.S. trade or business, or if they have no income from U.S. sources, or if their income is exempt from tax.

These are just some of the highlights and references of the U.S. tax regulations that cover taxation of income for foreign nationals working in the United States.

Why should you file a U.S. income tax return?

•   You may receive an income tax refund. If you had income tax withheld from your wages and/or other income received during the calendar year, you may owe less than the amount that was withheld. If there is a tax treaty between your home countr y and the U.S. and depending on your type of visa, part or all of your income may be tax exempt.
• Ensure non-U.S. income is not subject to U.S. income tax. If you hold certain types of visas, you will be considered a nonresident of the U.S. and only your U.S. source of income will be subject to U.S. income tax. Failure to file Form 8843, Statement for Exempt Individuals, may allow the IRS to treat you as a resident subject to U.S. income tax on your worldwide income. The IRS instructions to Form 8843 state that if you are an alien individual, you must file Form 8843 to explain the basis of your claim that you can exclude days of presence in the United States for purposes of the Substantial Presence Test because you were an exempt individual. Exempt individuals include teachers, trainees and students with either F, J, M or Q visas who substantially comply with their visa requirements. However, they conspicuously leave out students, teachers and trainees from exempt visa categories when identifying which visa category is in jeopardy to be reclassified as resident subject to U.S. income tax on their worldwide income. This however, is not done when stating who is required to file this form. A safe approach, if in an exempt category would be to file this form with IRS.
• Ensure U.S. income  tax deductions and income tax credits. The Internal Revenue Service may disallow all your income tax deductions and tax credits, if you are more than 16 months late in filing your U.S. income tax return.
• Not incur penalties and interest. Federal, state and local income tax authorities may impose stiff penalties and interest on tax owed and returns not filed. Income that is exempt by federal statute and U.S. income tax treaties, may not be exempt by the state and local income tax authorities.
• Meet requirements of U.S. visas. Visas generally require that you abide by the laws of the United States . If you don’t file your federal and state income tax returns, you could be viewed as not abiding by the U.S. income tax laws.

How income of foreign nationals is treated by the U.S. tax authorities?

• Foreign nationals - who became U.S. citizens, green card holders or residents for income tax purposes may have their worldwide income subject to U.S. income tax.
• Foreign nationals - who are treated as nonresidents of the U.S.- A) may have U.S. source income subject to U.S. income tax or exempt from tax B) may have U.S. source income exempt based on a tax treaty between the U.S. and the country the foreign national is a resident of.

What factors determine if a foreign national is a resident or a nonresident of the United States for U.S. income tax purposes?

• How long (Substantial Presence Test) in the U.S. and a Closer Connection Test (both tests are below)
• Tax elections a foreign national may make under U.S. income tax regulations (see below)
• Type of U.S. visa and activity while in the U.S. (see below)
• Income tax treaty between the USA and a country a foreign national is a resident of (see below)
• No Lapse Rule (see below)

Substantial Presence Test and Closer Connection Test

Substantial Presence Test –

1)     183 days or more in the U.S. in the current calendar year

2)      Look back - 183 days during a 3-year period that includes current period and the two years immediately prior to the current year

a)     31 days or more in current year

b)     1/3 number of days in first year prior to current period

c)     1/6 number of days in 2nd year prior to current period.

Foreign nationals who pass the above test would be classified as residents of the U.S., unless they can claim closer connection to another country (see immediately below) or are in a visa category that treats their limited or indefinite stay in the U.S. as not counting toward having a presence in the U.S. for income tax purposes.

Closer Connection Test – Form 8840

If you are in the U.S. for less than 183 days in the current year, but still qualify as a resident under the substantial presence test, you may be able to claim non residency under the U.S. income tax regulations, if you pass the Closer Connection Test:

A)   Maintain a tax home in a foreign country

B)    Permanent home

C)    Family resides

D)   Autos located and registered

E)    Drivers license

F)    Registered to vote

G)   Personal belongings

H)   Political and religious organization membership, etc.

Tax elections a foreign national can make under the U.S. income tax regulations

Joint return of income election -

Nonresident of the U.S. may elect residency status if married to a U.S. citizen, green card holder or a resident of the United States. Couples often do this to benefit from lower income tax rates and depending on their facts and circumstances, additional deductions (itemized and dependents) as well as tax credits that further lower their income tax. If they have paid income tax in their former country or countries of residency they will be entitled to a foreign income tax credit against their U.S. income tax up to the amount of tax that was calculated on the income taxed by other countries.

Electing to do a joint return subjects the foreign national and his spouse to the U.S. income tax on their worldwide income for the full calendar year.

First year election -

A foreign national may elect to be treated as a resident in the year preceding the year the foreign national is determined to be a resident under the substantial presence test, if a foreign national is in the U.S. for 31 days in a row or present 75% of days in the U.S. beginning with 31st day period and ending December 31st.  The terms of the election allow taxpayer to count 5 days in the U.S. when individual was out of the U.S. to meet 75% test under this election. Days individual is in the U.S. as exempt person (i.e. student, teacher, trainee temporarily in the U.S. or employee of foreign government, etc.) do not count.

Type of U.S. visa and activity while in USA

Categories below allow a Foreign National to be in USA as a non resident even though he is here well past the time that would cause a not exempt foreign national to be considered a resident under the Substantial Presence Test. The exempt status means he will not be considered a resident as long as they do not exceed the time allowed under the statute or the income tax treaty. When the income tax treaty, treats an item differently than the income tax statute, the income tax treaty rules are followed.

Below are examples:

Students – in the U.S. on F- Visa, M-Visa, J- Visa or Q-Visa can be treated as nonresidents in the United States for five calendar years as long as they substantially comply with the requirements of their visas. J- or Q-visa holders may be classified as nonresidents for shorter periods of time.

More liberal time limit may be available, if student shows that he/she has a closer connection to a foreign country and that the student has not taken steps to adjust his status to permanent resident (green card).

Teachers and trainees (J- and Q-visa, including J-2 and Q-2 visas for immediate family members [other than students holding these visas]). They may claim nonresidency for two succeeding calendar periods over a 6-year period as long as they substantially comply with the requirements of their visas. If all of alien compensation is from a foreign entity, the 2-year period may be extended to 4 years visa. If the same party had a student visa in this 6-year period, it must be counted as well toward the two-year or four-year period. H-visa does not qualify for nonresident exception of teachers and trainees.

Foreign Government – related individuals temporarily in the U.S. on diplomatic status, full-time diplomatic or consular status, full-time employees of international organizations and members of their families who are not U.S. citizens will not be considered residents as long as they hold a nonimmigrant visa and substantially comply with the requirements of their visa.

Other – there are a few other limited categories for foreign athletes, immigrants who are here for unexpected medical reasons and commuters from Canada and Mexico that may retain nonresident status.

Income tax treaty between the USA and a country a foreign national is a resident of

U.S. resident versus non-U.S. resident - Income tax treaties between the U.S. and other countries tie breaker clauses are determinative in classifying a foreign national as a resident or nonresident of the U.S. for purposes of claiming income tax treaty benefits. If the foreign national is determined to be a nonresident by the treaty tie breaker rules, he  or she could still be treated as a resident for all purposes of the IRS Code other than his ability to claim tax treaty benefits.

These treaty tie breakers often look to where tax payer has a permanent home, if in both countries than to the state where he has closer economic and personal relations, if still unclear in state where he has habitual abode and if he has habitual abode in both, than country of his nationality and lastly by competent authorities of treaty countries.

No lapse rule

The residency starting date and the residency termination date rules provide that if the alien was a resident alien at any time in the prior year or in the following year, the rules are superseded and instead the alien will be classified as a resident alien for the entire continuous period.

For example, if a nonimmigrant alien works for a number of years in the United States and moves out of the United States in 1997 with a residency termination date of 6/30/1997, his residency termination date will be revised if at any time in 1998 he again becomes a resident alien (for example, if he obtained a green card and entered the United States at any time in the year). Under those circumstances he would be classified as a resident alien through 12/31/1997 and also for all of 1998 (assuming that the alien did not then have a residency termination date for other reasons that was prior to 12/31/1998)

Social security

Students, trainees and teachers aren't subject to Social Security Tax if the services performed are consistent with the provisions of the visa held. Only foreign nationals on F-1, J-1, M-1 and Q-1 visas qualify for this exemption under the IRC Code. H-3 visas or B-1 visas specifically endorsed for training do not qualify for the exemption.

NOTE:The most common use of this exemption is for F-1 visa holders in the U.S. for practical training after graduation. For wages to be exempt from Social Security tax, the work must be consistent with the purpose for which the visa was issued. This means that the practical training is in an area consistent with the student's subject of study. Any part-time work (e.g., working in a restaurant after hours) doesn't qualify.