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Instructor: Carol Rutlen, CPA 650-321-3999 * * * * * * * * * Foreign Income Tax 986(a) Accrual basis translate into US dollars at the average ... – PowerPoint PPT presentation

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Title: Instructor:

  • Instructor
  • Carol Rutlen, CPA
  • 650-321-3999

Key Points
  • Taxation of nonresident alien (and foreign
  • US source
  • Effectively Connected Income (ECI)
  • Non ECI
  • Foreign currency translation
  • Qualified business unit
  • Foreign income taxes

Nonresident Alien - Income
  • Effectively connected (ECI)
  • Connected to a US trade or business
  • Compensation for personal services (sourced based
    on where services are performed)
  • Profits from operation of business in US
  • Income from partnership doing business in US
  • Income from real property (if election is made to
    treat as effectively connected)
  • Sale of US real property
  • Sale of business-related capital assets
  • Interest, dividends, etc. from assets or
    activities of US trade or business
  • Taxed at regular graduated rates

Nonresident Aliens Deferred Payments
  • 864(c)(6) Treatment of Certain Deferred
    Payments, Etc. Income or gain of a NRA or
    foreign corporation which
  • (A) is taken into account for any taxable year,
  • (B) is attributable to a sale or exchange of
    property or the performance of services in any
    other taxable year
  • Shall be made as if such income or gain were
    taken into account in such other taxable year

Nonresident Alien - Income
  • Not effectively connected
  • Investment income
  • Passive income
  • Examples
  • Dividends
  • Interest
  • Rents and royalties
  • Alimony
  • Limited capital gain
  • Taxed at flat 30 rate or lower treaty rate
  • Exempt from US taxation
  • Interest on deposits with banks 871(h) and (i)
  • Certain portfolio obligations
  • Most capital gains

Nonresident Alien Capital Gain
  • 871(a)(2) interaction with 7701(b)(2)
  • If NRA is in US 183 days, all US source capital
    gains are taxable
  • If NRA is in US lt 183 days, no US source capital
    gains are taxable
  • Exception
  • Gain on sale of US real property interests
  • 865(a)(2) gain from sale of personal property
    sourced on tax home

Nonresident Alien - Deductions
  • Itemized deductions allowed only for expenses
    connected to ECI (e.g., state income tax)
  • Casualty losses to property located in the US
  • Contributions to US charities
  • Allowed only against effectively connected income
  • No standard deduction
  • Only one personal exemption
  • No deduction/credit for foreign taxes
  • MFS rates, no head of household or MFJ rates

Nonresident Alien Filing Requirements
  • 864(b)(1) No US tax if the alien earns less
    than 3000 and is in the US for less than 90 days
  • 1.6012-1(b)(2)(i) NRA not engaged in trade or
    business in the US at any time during the taxable
    year are not required to file US return if the
    tax liabilities are fully satisfied by
    withholding at source
  • 1.6012-1(b)(1)(i) NRA engaged in US trade or
    business must file returns even if
  • No effectively connected income or domestic
    source income is recognized or
  • Income is exempt by statute or treaty

Nonresident Alien - Taxability
  • Taxed when received, not when earned or accrued
  • Potential treaty benefits for dependent personal
  • Typical requirements
  • Must be tax resident in home country
  • Cost must be borne outside of the US
  • Must not be present in US for more than 183 days
  • Economic employer rules primarily in Europe

F, J, and Q Visa
  • Granted to alien students, scholars, trainees,
    teachers, professors, etc. and their spouses and
    children for the purpose of teaching,
    instructing, lecturing, studying, observing, etc.
  • Section 872(b)(3)
  • No federal tax is imposed
  • Taxpayer must be paid by foreign employer
  • J visa holders days exempt 7701(b)(5)(A)
  • Not counted in substantial presence test
  • 7701(b)(5)(E) not treated as exempt if for any
    2 calendar years during the preceding 6 calendar
    years the person was exempt
  • Compensation qualified under 872(b)(3) not
    treated as exempt if for any 4 calendar years
    during the preceding 6 calendar years the person
    was exempt
  • No FICA taxes

F, J, and Q Visa - states
  • California, PA do not follow these rules
  • PA has domicile requirement plus permanent
    abode/183 day rule
  • NYS follows Federal

Dual Status
  • Arrival US resident for part of year that
    begins with residency start date nonresident
    before that date
  • Departure US resident for part of year the ends
    with residency end date nonresident after that
  • Doesnt apply if you make election to be treated
    as a full year resident

Dual Status
  • During residency period taxed on worldwide income
  • Follows residency rules
  • Includes amounts earned while nonresident, but
    received while resident
  • During non-residency period taxed as nonresident
  • Tax treaty provisions usually limited to
    nonresident period

Dual Status
  • Itemized deductions
  • Allowed for period of residence
  • Deductions against non-ECI income limited
  • Standard deduction considered NRA not
  • Combine ECI and all income while a resident to
    determine tax under graduated rates
  • Foreign tax credits claimed for residency period

Dual Status
  • Exemptions
  • Taxable income for period of residency 1
  • Spouse 1 exemption if has no gross income and
    isn't the dependent of another taxpayer
  • Dependent exemptions allowed
  • Exemptions for spouse and dependents cant exceed
    taxable income for the period of residency
  • Special rules of Canada, Mexico, or Korea apply
  • Cant use Head of Household
  • Cant file joint return
  • Married residents of Canada, Mexico, or Korea may
    file single if live apart from spouse during last
    6 months of the year

Full Year Resident vs. Dual Status
Before Assignmt During Assignmt Total
Salary Deductions Exemptions 50,000 50,000 -1,000 -6,800 100,000 -10,700 -6,800
Taxable Inc 42,200 82,500
Tax FTC 6,968 -0- 13,479 -6,740
Tax after FTC 6,968 6,739
Community Property Rules
  • General definition
  • Disregarded if
  • both H W are NRA
  • H or W is NRA and other is US citizen or RA
  • Separate property income
  • Earned income
  • Trade or business
  • Partnership income

Filing Status
  • Resident alien file 1040
  • Nonresident alien file 1040 NR
  • Dual status
  • Both a resident alien and a non resident alien in
    the same year
  • Usually applies in arrival and departure year
  • Income/deductions is separated into RA and NRA
  • Taxed when received, not when earned
  • Claim itemized deductions during RA period
  • Cant claim standard deduction
  • Personal exemptions for self, spouse, and
  • Single single, no head of household
  • Married MFS, unless elects to be taxed as
    full-year residents

Practical Issues
  • Year of arrival
  • Resident at year end, 1040NR under 1040
  • Full year resident only 1040
  • Year of departure
  • NRA at year end, 1040 under 1040NR
  • Tax on 1040 carries to 1040NR
  • 1040NR filed with IRS in Austin, TX
  • Social security numbers
  • If alien has a valid visa, they must get a social
    security number
  • Must go to social security office while in the US
    and file Form SS-5
  • If they dont get SSN while in US, then they need
    to go to the embassy to obtain a SSN
  • Cant qualify for an ITIN
  • If not eligible for SSN, apply for ITIN
  • Form W-7
  • For tax processing only
  • Doesnt entitle recipient to social security

Sailing Permits
  • Foreign citizens must obtain a certificate of
    compliance before permanently departing from the
  • Departure permit or sailing permit
  • Part of Form 1040C or Form 2063
  • Must be filed before leaving
  • Exemption for diplomats, alien students,
    industrial trainees, exchange visitors, and
    others who have no income subject to tax
  • All US tax due up to date of departure must be
  • Form 2063 short information form 1.6851-2(b)
  • No taxable income for year of departure and for
    preceding year
  • RA who continue resident status in the US
  • RA who received taxable income in current year or
    preceding year and whose departure will not
    hinder the collection of tax.
  • Regular income tax return still required for year
    of departure
  • Practical answer no one files

Planning a Transfer
  • Timing of transfer
  • Timing receipt of income
  • Sale of principal residence
  • Sale of other capital assets
  • Exercise of stock options
  • Timing the payment of deductible expenses

Withholding on US-Source Non-Business Income
  • Persons subject to withholding
  • Nonresident alien individuals
  • Foreign corporations
  • Foreign partnerships
  • Foreign estates and trusts
  • 1441 income subject to withholding
  • Fixed or determinable, annual, or periodical
  • Derived from sources in US
  • 85 of the social security benefits received by
    NRA are subject to 30 withholding tax 871(a)(3)

Withholding on US-Source Non-Business Income
  • Applicable tax rate
  • 30
  • Except
  • Portfolio interest
  • Disposition of US real property interest
  • Foreign partners distributive share of
    partnerships ECI
  • 14 withholding rate for certain scholarships and
    fellowships received by NRA
  • Treaties, usually 15
  • Reported on 1042S

Withholding on US-Source Non-Business Income
  • Withholding agent
  • Obligated to withhold
  • Any person having control, receipt, custody,
    disposal, or payment of an item of US-source
    non-business income to a foreign person
  • Corporations distributing dividends
  • Debtors paying interest
  • Tenants paying rent
  • Licensees paying royalties
  • Agent liable for uncollected tax
  • Form W-8, W-8BEN or W-9 submitted to withholding
  • Deposits tax and files annual informational return

Withholding on US-Source Non-Business Income
  • Administrative matters
  • Potential for abuses
  • US citizens
  • NRA
  • Reduced withholding tax rates under US income tax
    treaties are only available to non-US beneficial
    owners that reside in a treaty country
  • Withholding agent (payor) can rely on submitted
  • If payee fails to provide adequate documentation
  • Presumption that payee is US person
  • 28 backup withholding

Withholding on ECI
  • Withholding not required on US-source income
    effectively connected with US trade or business
  • Personal services withholding exemption doesnt
    apply unless compensation is
  • Subject to standard wage withholding
  • Exempt from withholding 3402
  • Received by self-employed resident of Canada or
  • Exempt from tax by reason of a treaty exemption
  • Subject to a withholding agreement
  • ECI for foreign partner in partnership
  • Withhold tax at specified rate for partner
  • Maximum tax rate for individual or corporation
  • Partnership remits quarterly tax payment

Foreign Corporations
  • Created/organized in another country
  • May be classified as different type of entity
  • How to market products in US
  • How will foreign company be taxed

Foreign Corporations
  • Taxed on
  • Non-effectively connected income
  • Effectively connected income
  • Similar to NRA rules
  • Tax treaties address PE issues
  • Choice of entity/type of operations
  • US subsidiary
  • Branch
  • State tax issues

Foreign Corporations
  • Basic planning
  • Interplay of tax laws in each country
  • US tax on US sourced income
  • Foreign tax credits
  • Repatriating profits
  • Future classes will cover
  • Controlled foreign corporations (CFC)
  • Foreign personal holding companies (FPHC)
  • Passive foreign investment companies (PFIC

Foreign Currency Translation
  • US tax liability determined and paid in US
  • 985(a) taxpayer generally must make all US tax
    determinations in functional currency
  • Usually US
  • Foreign currency is the functional currency if
  • QBU (qualified business unit)
  • Economic environment is in the foreign country
  • Maintains books and record in foreign currency
  • Non QBU
  • Transactional exchange gains and losses arise
    when the exchange rate fluctuates between the
    time a transaction is entered into and when it is
    closed out
  • Translate each part of transaction at appropriate
    exchg rate
  • If QBU functional currency not US, profit (loss)
    translated into at avg exchange rate

Foreign Currency Translation
  • Always a QBU (separate and clearly identified
    unit of a trade or business)
  • Corporation
  • Partnership, trust, and estate
  • Not a QBU
  • Activities of an employee
  • But activities of an individual conducted as a
    sole proprietor if foreign currency is used and
    books and records maintained in foreign currency
    can constitute QBU

Qualified Business Unit
  • Example foreign rental property
  • If QBU
  • All income and expense of property
  • Converted at weighted average exchange rate for
    the year
  • Who can elect taxpayer who has not had foreign
    rental income or loss in prior year
  • Who cant elect
  • Reported prior foreign rentals
  • Doesnt meet requirements, i.e., separate books
    and records

Foreign Currency Translation
  • Adoption of functional currency is method of
  • Once adopted must be used for all subsequent
    taxable years
  • Can apply for permission to change usually
    granted only if currency changes for US financial
  • 988 entire gain or loss arising from disposition
    of a nonfunctional currency is treated as an
    exchange gain or loss
  • For US tax purposes, only US is money
  • Other currency treated as property with a tax
  • Transactions with debt instruments, receivables,
    or payables accounted for separately from gain or
    loss on underlying transaction
  • Character ordinary income or loss
  • Source Tax home of taxpayer or QBU
  • 988(e) personal transaction no exchange gain
    unless gain exceeds 200 per transaction

Foreign Income Tax 986(a)
  • Accrual basis translate into US dollars at the
    average exchange rate for the tax year EXCEPT
  • Foreign tax paid more than 2 years from the close
    of the tax year
  • Foreign tax paid in a tax year prior to the year
    to which they relate
  • Foreign tax paid in inflationary currency
  • Cash translated using exchange rate on the date
    of payment
  • Adjustment to the amount of the taxes is
    translated using the exchange rate at the time
    the adjustment is paid
  • Refund or credit use exchange rate when the
    original payment made

NRA Estate Tax
  • 60,000 exemption for estate tax purposes
    (13,000 unified credit)
  • On property situated in US
  • Stock in US corporations
  • Unexercised options
  • US property
  • Potential estate treaty benefits

Key Points
  • Taxation of nonresident alien
  • US source
  • Effectively Connected Income (ECI)
  • Non ECI
  • Foreign currency translation
  • Qualified business unit
  • Foreign income taxes

Contact Information
  • Carol Rutlen
  • 650-321-3999