Taxation Guidance on Employee Payments to U.S. Citizens, Permanent Residents, and Resident Aliens

Purpose

This document describes the Internal Revenue Service (IRS) taxation rules, requirements, and Research Foundation responsibilities associated with employee payments to U.S. Citizens, permanent residents, and resident aliens for tax purposes. This document also outlines general exemption rules for "expatriate" employees.

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."

Residency for Tax Purposes

The residency status of nonresident aliens refers to residency for tax purposes as follows:

Definition of Employee Income

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.

Assisting Employees with Tax Forms

Operating locations should, if necessary, assist employees with the preparation of any necessary forms. Operating location staff must NOT offer tax advice.

Taxation Overview

All income paid to an employee or payments that benefit the employee are taxable income. This means the income is “subject” to taxation or tax withholding. Under the IRS tax rules the income is taxable unless there is a specific IRS rule that exempts the payment from taxable income for an employee or provides special rules for taxation or reporting.

United States (U.S.) citizens, permanent residents (Green Card), and resident aliens (Substantial Presence Test) are subject to taxation on their worldwide income. Therefore, no matter where in the world the services are performed, the income is subject to taxation and reporting at calendar year end on a W-2, "Wage and Tax Statement."

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." 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.

Employees must complete federal and state withholding allowance certificates to designate the amount to withhold from biweekly payroll. Refer to the "Required Forms" section in this document for more information. Tax status, withholding allowances, and exemption determination is the responsibility of employees, who will reconcile with the IRS on individual tax liability vs. taxes withheld when they file their individual income tax return at year end.

Exempt and Nonexempt Taxable Income

An employee's income is taxable unless there is a specific IRS rule that exempts the payment from taxable income or provides special rules for taxation or reporting. Some examples of tax exempt and nonexempt income are provided below:

Examples of exempt income:

Examples of income with special withholding and reporting rules:

Examples of income that is not exempt:

Required Forms

Employees are required to complete the following forms stating their tax status, withholding allowances, and any additional amounts they would like withheld:

Tax

Required Form

Federal

IRS Form W-4, " Employee's Withholding Allowance Certificate"

Note: This form is also used to claim tax exemption for standard liability tax exemptions. Resident aliens claiming exemption under an income tax treaty must complete a different form. See the section "Exemptions" below for details on both situations.

New York State

NYS IT-2104, "Employee's Withholding Allowance Certificate"

Note: This form cannot be used to claim an exemption. Exemption is claimed on IT-2104E. See the section "Exemptions" below for details.

Required Forms for Tax Exemption

Employees are required to complete the following forms to claim exemption from tax withholding:

To claim exemption from . . .

Employees must complete:

federal taxes

IRS Form W-4, " Employee's Withholding Allowance Certificate"

New York State taxes

NYS IT-2104E, "Certificate of Exemption from Withholding"

Resident Aliens

Some non U.S. citizens who are resident aliens for tax purposes may be able to claim income tax treaty exemption under an exception to the Savings Clause within an income tax treaty. The exemption from income tax may be partial or full, depending on the income tax treaty agreement. Resident alien's claiming income tax treaty exemption receive a 1042-S for the amount exempt under the income tax treaty and a W-2 for any remaining wages. Refer to the procedure "Using Income Tax Treaties and Quick Reference Tables" for information on how to determine if a tax treaty applies. If a tax treaty does apply, employees are required to complete the following form:

To claim exemption . . .

Resident alien must complete:

under an income tax treaty . . .

IRS Form W-9, "Request for Taxpayer Identification Number and Certification" and the required supporting statement. Refer to the procedure, "Completing IRS Form W-9 for Resident Aliens Requesting Tax Treaty Exemption" for detailed instructions and sample completed forms.

Note: 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 "Processing Taxation and Exemption of Employee Payments to U.S. Citizens, Permanent Residents, and Resident Aliens" for more information.

Expatriates

Employees who are U.S. citizens who live and work in another country are called expatriates. Expatriates may be subject to different exemptions. Expatriates must complete one of the following to claim exemption:

To claim exemption from . . .

Expatriates must complete:

federal and New York State taxes

IRS Form 673, "Statement for Claiming Exemption from Withholding on Foreign Earned Income Eligible for the Exclusion(s) Provided by Section 911" (the form also provides information on who is eligible for exemption and instruction for claiming the exemption).

OR

IRS Form W-4 and NYS IT-2104E.

Non New York State Residents

A person living and working in another state may be able to claim full or partial exemption from New York State taxes. The following form is required:

To claim exemption from . . .

Non New York State residents must complete:

New York State taxes

NYS IT-2104.1, "New York State, City of New York, and City of Yonkers Certificate of Nonresidence and Allocation of Withholding Tax"

Note: The Payroll module of the RF business system does not withhold out of state income taxes. To establish out of state tax withholdings, the employee may choose to pay estimated tax to the state they live and work in.

Questionable Withholding Allowances

Federal Taxes

In some cases, the IRS may send the RF a letter indicating that taxes must be withheld at a different rate then the employee stated on IRS Form W-4. Effective April 14, 2005, potentially questionable W-4 forms, such as an individual claiming tax exemption, or claiming more than 10 withholding allowances, are no longer required to be submitted by the Research Foundation to the IRS. The IRS will instead ensure that employees have enough federal income tax withheld from their paychecks by reviewing W-2 Wage and Tax Statements and individual tax returns. In cases where under withholding is found, the IRS will issue a "Lock in" letter to the RF with special instructions on tax withholding. After receiving a letter, the RF central office must code the withholding change in the RF business system in accordance with the terms of the IRS letter and distribute an IRS letter to the employee explaining the process.

New York State Taxes

If an employee claims more than 14 withholding allowances on NYS Form IT-2104 or is claiming exemption from state income tax withholding on NYS Form IT-2104E and his or her exempt wages exceed $400 biweekly, the operating location must send a copy of the form to the Corporate Payroll Unit of the Central Office of Human Resources. The Research Foundation then must submit copies of the IT-2104 or IT-2104E to New York State.

Taxation and Exemption Information in the RF Business System

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.

The payroll module displays an employee's tax status on the Federal Tax Rules form, the State Tax Rules form, the County Tax Rules form, and the City Tax Rules form, accessed through an employee's assignment record. Each one of these forms contains a "Tax Exemption" region for recording tax exemptions. If the employee is exempt per federal or state forms, the FIT or SIT box in the "Tax Exemption" region must be selected. Taxes will be withheld if the FIT or SIT exemption boxes are left blank.

Refer to the procedure, "Processing Taxation and Exemption of Employee Payments to U.S. Citizens, Resident Aliens, and Permanent Residents" for more information.

Income Tax Refund Requests

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:

Importance of Reviewing Data in the System

Information contained in reports and year-end tax statements is collected from the data stored in the RF's business application. If data are 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 Taxation for information on monitoring employee income tax withholding or exemptions.

Key Data to Review

Areas that should be reviewed for accuracy are described below.

Employee assignment classification:

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 (refer to "Definition of Employee Income" at the beginning of this document). 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 an independent contractor or fellow).

For more information on classification, refer to the following procedures:

Residency status

Operating locations should have non citizen aliens fill out the "Request for Alien Information for Employees and Fellows” (pdf) (Excel) form 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).

Refer to "Processing Taxation or Exemption of Employee Payments to Nonresident Aliens" for information on inputting taxation information to the RF business system and processing residency changes.

Change History

 

 

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