This document describes the Internal Revenue Service (IRS) taxation rules, requirements, and Research Foundation responsibilities associated with employee payments to nonresident aliens for tax purposes.
Note: This procedure addresses income tax rules only. Social Security and Medicare taxation for employees payments is a separate government tax. For more information on Social Security and Medicare taxation, refer to the document "Social Security and Medicare Taxation."
The residency status of nonresident aliens refers to residency for tax purposes as follows:
See "Classifying Aliens as Resident or Nonresidents for Tax Purposes" for more information on classification. See "Taxation Guidance on Employee Payments to U.S. Citizens, Permanent Residents, and Resident
Aliens" for taxation information for U.S. citizens, permanent residents, and resident aliens.
Employee income payments are payments for services rendered by an employee. This typically means an employer has discretion to direct or control the content of work, the results to be accomplished, and the means by which the person accomplishes the work. The work is “key” to the business operation, with set hours and a continuing relationship.
Operating locations should, if necessary, assist nonresident aliens in the preparation of any necessary forms. Operating location staff must NOT offer tax advice.
A separate tax system exists for nonresident aliens within the Internal Revenue Code (IRC) section 1441. Payments to nonresident aliens are subject to very different tax withholding, income reporting and liability requirements than that of U.S. citizens, permanent residents, and resident aliens.
Various factors determine if payments are reportable and taxed, depending on the specific circumstances of each nonresident alien's payment and their country of residence.
Employees must complete the federal and state withholding allowance certificates according to IRS rules provided in IRC 1441. The nonresident alien is restricted under the rules on how they may fill out the withholding allowance certificates. See the "Required Forms and Withholding Rates" section later in this document for more information. Nonresident aliens are not allowed to claim exemption on IRS Form W-4 or NYS-2104E. Employees reconcile with the IRS on individual tax liability vs. taxes withheld when they file their individual income tax return at year end.
The federal and state governments provide “graduated rate tables” to employers to calculate the amount the employer must withhold from wages each pay period. Refer to IRS Publication 15, Circular E, "Employer's Tax Guide." In addition, as of January 2006, new tax withholding rules on nonresident alien employees were put into place. Employers must add an amount to the wages of the nonresident alien employee solely for the purpose of calculating the income tax withholding for each pay period. Refer to the procedure, "Processing Taxation and Exemption of Employee Payments to Nonresident Aliens," for more information.
If the employee provides an invalid federal or state form or no form at all, operating locations must withhold taxes at a default rate defined by the government of: Single and 0 allowances, which results in the highest graduated tax withholding rate.
Nonresident aliens for tax purposes are only subject to tax withholding and reporting on income deemed "U.S. source" income. For income from services, such as employee and independent contractor income, the sourcing rule is based on where the service is performed. Any service performed by employees and independent contractors in the U.S. is considered "U.S. source" income and is taxable.
Nonresident aliens performing services outside the U.S. (income deemed "foreign source") should not have an employment relationship with the Research Foundation (RF) and should instead be hired through
a third party employer or as an independent contractor. IRS rules do not apply to foreign source income and the individual is not protected by many federal employment laws, including the U.S. Equal Employment Opportunity laws (Title VII). In addition, because the employment rules differ from country to country, are often complex, and are subject to change without notice, it is difficult to ensure that an employee relationship meets the requirements of each country. Refer to the "Employment of Noncitizens Outside the U.S. Policy" for more information.
Nonresident alien employees are required to complete the following forms with the required tax status and withholding allowances:
Special Withholding Rates that Generally Apply
Required Form *
Single, 1 allowance, and must write "nonresident alien" or "NRA" above the dotted line leading to the box for "additional withholdings."
Exceptions: If you are a resident of American Samoa, Canada, Mexico, Northern Mariana Islands, South Korea or a student from India, there are exceptions to these rules. Refer to the next section "Exceptions to the Standard Withholding Rate" for details.
New York State
Single, 1 allowance, and must write "nonresident alien" or "NRA" above the dotted line leading to the box for "additional withholdings."
* Noncitizen employees cannot claim exemption on IRS Form W-4 or NYS IT-2104E. The only valid form for claiming income tax treaty exemption is IRS Form 8233 (refer to the "Tax Treaty Exemption" section below).
Nonresident aliens who are residents of American Samoa, Canada, South Korea, Mexico, the Northern Mariana Islands, and students from India may, in certain cases, be permitted to claim an additional withholding allowance for their spouse and dependents. If an individual qualifies for an additional exemption, he will be entitled to claim it using IRS Form W-4. The rules are as follows:
The nonresident alien's income may be exempt if the person's country of residence has an income tax treaty exemption agreement with the U.S. and the nonresident alien claims the exemption by completing
an IRS Form 8233, "Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual" and supporting statement from IRS publication 519. The exemption from income tax may be partial or full, depending on the income tax treaty agreement. Nonresident alien employees claiming income tax treaty exemption receive a 1042-S, "Foreign Person's U.S. Source Income Subject to Withholding" statement for the amount exempt under the income tax treaty and a W-2, "Tax and Wage Statement" for the remaining taxable wages.
The nonresident alien employee must complete IRS Form 8233 and supporting statement from IRS Publication 519 to request the exemption. Completing the form and determining if exemption applies is the responsibility of the employee. Employees reconcile with the IRS on individual tax liability vs. taxes withheld when they file their individual income tax return at year end.
Operating locations must review and approve the form. Refer to the procedure "Using Income Tax Treaties and Quick Reference Tables" for information on how to determine if a tax treaty applies and the form procedure "Completing IRS Form 8233 for Nonresident Aliens Requesting Tax Treaty Exemption" for instructions on claiming the exemption and completing the form.
If the person claims exemption under an income tax treaty, the exemption must be recorded in the Non Citizen Reporting Special Information Type (SIT). If you do not enter the appropriate information in the Non
Citizen Reporting Information SIT, the treaty exempt income will be reported on the W-2 in error. Refer to the next section, "Processing Taxation and Exemption in the RF Business System" for more information
Employee taxation and exemption information is entered into the RF business system based on the information provided by the employee on the required tax forms. When payroll runs, it looks at the person's status in the system and calculates the taxes based on "graduated rate tables" that the federal and state governments provide to employers to calculate the amount the employer must withhold from wages each pay period. The graduated rate tables and updates are provided to the RF through a third party software company called Vertex.
Tax forms in the payroll module contain an employee's tax status. Through an employee's assignment record, you can access the Federal Tax Rules form, the State Tax Rules form, the County Tax Rules form, and the City Tax Rules form. Each one of these forms contains a "Tax Exemption" region for recording tax exemptions. If the employee is exempt per IRS Form 8233 and a supporting statement, the FIT or SIT box in the "Tax Exemption" region must be selected. Taxes will be withheld if the FIT or SIT boxes are left blank.
Refer to the procedure, "Processing Taxation and Exemption of Employee Payments to Nonresident Aliens," for more information.
Income taxes must be withheld or exempted based on the status of the individual during each pay period. Income tax status changes provided on new forms are not retroactive to previous time periods. Therefore,
there are no income tax refunds.
For example, if an employee has been working for the RF since January 1 but does not claim the treaty exemption until March 31 by filing the completed IRS Form 8233 and supporting statement from IRS publication 519, the tax exemption does not start until the pay period the forms and statement were completed, reviewed, and approved. In this case, the exemption should not start until the pay period March 31 falls within. Assuming the employee worked the remainder of the year and the treaty exemption was valid, the employee receives a W-2 for the taxable income from January through March and a 1042-S for the income that was treaty exempt April through December.
Information contained in reports and year-end tax statements is collected from the data stored in the RF's business application. If data is missing or inaccurate, tax statements will be missing or inaccurate. Correcting tax statements after they have been created and distributed is an administrative burden for staff at both the operating locations and at the central office. Corrections are also an inconvenience to the person receiving the corrected tax statement from the RF.
Any errors, such as misclassification or tax withholding errors, may bring significant risk exposure to the RF, and may result in penalties and fines, which would be passed on to the operating location responsible. Operating locations should have a procedure in place for reviewing the input in the RF business application so that accurate income tax withholding or exemption is maintained throughout the year.
Refer to Monitor Employee Income Tax Withholding for information on monitoring employee income tax withholding or exemptions.
Areas that should be reviewed for accuracy are described below.
Is the payment classified correctly? What is the relationship of the individual with the RF?
To minimize any possible risk in this area, evaluation of the employee assignment should be made before the person is ever added to the RF business system. The nature of the activity should meet the RF definition for an employee. Errors in misclassification typically have a significant impact on taxes, reporting, or fringe benefit charges (e.g., if an employee is paid in error as a fellow).
For more information on classification, refer to the following procedures:
Operating locations should have non U.S. citizens fill out the "Request for Alien Information for Employees and Fellows” form (pdf) (excel) to gather pertinent information and should use the Substantial Presence Test (Test 3 located on the back of the form to determine residency for tax purposes.
If a noncitizen's residency status changes during the calendar year, taxes and reporting are based on residency status at the time that a payment is made to the employee. For those non U.S. citizens who
meet the criteria of the IRS Substantial Presence Test, the “residency starting date” for tax purposes is the first day of presence in the U.S. during the calendar year in which the individual meets the test.
The IRS rules explain that income tax withholding or exemption must be processed each pay period based on the residency status for tax purposes and tax status of the employee. Although the IRS residency determination rules are not in full agreement with the IRS withholding rules, to ensure that withholdings are processed in a compliant manner, taxes should be withheld (if applicable) based on the tax status at payment (according to IRS withholding rules).
Proper coding in the RF business system is critical to ensure that payments are taxed appropriately based on the residency status and tax status at the time of payment, and that year-end reports are accurate. In most cases, you should be able to forecast the change in residency status at the beginning of the year of activity when calculating the Substantial Presence Test (SPT).
Not every country has an income tax treaty agreement with the United States. A treaty must exist between the individual’s country of residence and the United States. If the fellow completes, signs, and dates an IRS Form 8233 to claim income tax treaty exemption, you must review the form to ensure data is complete and that the income tax treaty exemption appears valid. Refer to the procedure, "Completing IRS Form 8233 for Nonresident Aliens Requesting Tax Treaty Exemption" for detailed instructions and sample completed forms.
Nonresident aliens for tax purposes must have data in the Non-Citizen Reporting Info special information type (SIT) form if they claim income tax treaty exemption. This data drives how the 1042-S will be produced.
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