In contrast to U.S. citizens and green card holders, nonresident aliens (“NRAs”) are subject to U.S. tax in a more limited manner. NRAs are not subject to U.S. tax on their worldwide income. They can be subject to U.S. tax, however, on certain U.S. source “passive” income (e.g., dividends from a U.S. corporation) and income generated from a U.S. trade or business or from the sale of U.S. real estate.
In such case, a nonresident alien may be required to file a non-resident federal income tax return - the IRS Form 1040-NR. The Form 1040-NR is significantly less complex than the Form 1040 filed by U.S. persons, but it does present a number of information-gathering challenges.
Who is a Nonresident Alien?
A nonresident alien for tax purposes is a person who is not a citizen of the United States or a green card holder and is not considered “resident” in the United States for tax purposes.
The basic test for determining tax residency is the substantial presence test. Under this test, an individual will be considered a U.S. resident for tax purposes if he or she is physically present in the United States on at least: (a) 31 days during the current calendar year; and (b) A total of 183 days during the current year and the 2 preceding years, counting all the days of physical presence in the current year, but only one-third the number of days of presence in the first preceding year, and only one-sixth the number of days in the second preceding year.
Example – John, a Canadian citizen, was physically present in the United States for 150 days in each of the years 2020, 2021, and 2022. For the last year (2022), John held a business visa, while for the first and second years (2020 and 2021), he held a teacher’s visa. At the outset, John would fail the substantial presence test, because of the 150 days of presence in 2022, 50 days in 2021 (1/3 of 150), and 25 days in 2020 (1/6 of 150), together with total 225 days, which is greater than the 183-day threshold. However, since John held a teacher’s visa in 2020 and 2021, his days of presence in the United States during those years are not counted. As such, John should not be considered a U.S. tax resident under the substantial presence test for 2022. Instead, he should be considered a nonresident alien for U.S. federal income tax purposes.
You are treated as present in the United States for purposes of the substantial presence test on any day you are physically present in the country, at any time during the day. However, there are exceptions to this rule. Examples of days of presence that are not counted for the substantial presence test include:
- days you are in the United States for less than 24 hours, when you are in transit between two places outside the United States; and
- days you are an exempt individual (which includes certain teachers, students, and professional athletes
Other exceptions to the substantial presence test include:
The closer connection exception – Under U.S. tax law, even if you fail the substantial presence test, you can still be treated as a nonresident alien if you maintain a “tax home” in a foreign country during the year and have a “closer connection” during the year to one foreign country in which you have a tax home than to the United States.
Treaty exception – Under an applicable U.S. tax treaty, an individual may be subject to a less onerous test than the substantial presence test.
It is important to note that there are specific form filing requirements associated with each of the above exceptions (e.g., Form 8840 for the closer connection test and Form 8833 for treaty relief). Such forms must generally be timely filed with a Form 1040-NR. An expat tax professional should be consulted to ensure that the proper filings are executed, otherwise, these important exceptions may otherwise be unavailable.
Do Nonresident Aliens Have to File U.S. Tax Returns?
While the U.S. government taxes its citizens and tax residents on worldwide income and subjects them to certain anti-deferral regimes, it taxes foreign persons, including nonresident aliens, in a more limited manner.
First, foreign persons are generally subject to tax on U.S.-source “FDAP” (fixed, determinable, annual, or periodic) income, which includes passive-type items, such as interest, rent, royalties, and dividends. This income is taxed on a gross basis (i.e., with no offsetting deductions) at the rate of 30% by way of withholding at source by the U.S. payer, who has primary responsibility as the “withholding agent” to collect, deposit, and report the tax to the IRS. Failure to do so can expose the U.S. payer and foreign person to significant penalties and interest.
A nonresident alien’s U.S.-source net capital gains — gains in excess of losses from the sale of investment property — are not subject to U.S. federal taxation unless the alien is in the United States for at least 183 days during the year. The general exemption from U.S. taxation for capital gains applies regardless of the number of transactions or amount of gain realized during the taxable year. The exemption does not apply in the case in the case of real property investments.
Second, foreign persons who are considered to earn income “effectively connected” with a trade or business in the U.S. (in contrast to the passive-natured FDAP income) are subject to tax at graduated rates on a net basis (i.e., reduced by available deductions). U.S. payers generally do not need to withhold tax on such effectively connected income (“ECI”).
The deductions that can be taken by a NRA against ECI are limited to personal exemptions, contributions to U.S. charities, and other expenses that are related to the earning of the ECI. Examples of such related expenses are travel expenses incurred in performing services in the U.S. while temporarily away from home, contributions to individual retirement accounts, and state and local income taxes imposed on the NRA’s ECI. NRAs are not allowed to use the standard deduction.
With respect to filing, a foreign person must report U.S.-source FDAP (with some exceptions) and ECI on an annual basis on the Form 1040-NR. As to the difference between the 1040-NR and 1040-NR-EZ, you can file using the shortened EZ form if your only U.S. source income was from wages, salaries, tips, refunds of state and local income taxes, scholarship or fellowship grants, and nontaxable interest or dividends.
The United States government has a number of income tax treaties with foreign countries. Tax treaties can often reduce or eliminate U.S. tax on various types of income of a nonresident alien, including interest, dividends, royalties, capital gains and pensions. Beneficial provisions are usually not available with respect to income from the sale of U.S. real estate. It is important to note that each individual income tax treaty should be reviewed and analyzed to determine whether specific types of income are exempt from U.S. tax or taxed at a reduced rate, and what conditions apply to such exemptions and reductions.
It should be noted that in order to utilize a treaty provision, taxpayers must include IRS Form 8833 (Treaty-Based Return Position Disclosure) with their expat tax returns – Form 1040NR or 1040NR-EZ – and disclose their position.
By filing a protective return, a nonresident alien protects his or her right to receive the benefit of deductions and credits in the event it is later determined that some or all of the person’s income is effectively connected. Nonresident aliens are not required to report any effectively connected income or any deductions on the protective return but must explain on the return that it is being filed as a protective return.
Nonresident aliens are generally required to file their returns – Form 1040NR or 1040NR-EZ – by June 15th of the following year.
However, if you were an employee and received wages subject to U.S. income tax withholding, Form 1040NR must be filed by April 15th day of the following year. If you cannot file your return by the due date, you can file Form 4868 to get an automatic 6-month extension.