The types of U.S. tax withholding applicable to payments to nonresidents working in the U.S. vary based on the type of visa they possess, a tax manager said May 14.
Applicability of an income tax treaty or a social tax totalization agreement between the U.S. and a nonresident employee’s home country, and whether the nonresident employee has fulfilled the requirements of the substantial presence test, may modify the U.S. taxability that otherwise would be in effect for the nonresident employee based on the type of visa the employee possesses, said Mindy Harada Mayo, CPP, principal and practice leader of human capital tax at Ryan LLC.
“Visa types will dictate whether a person can be on a U.S. payroll or not,” Mayo said at the annual American Payroll Association Congress in Long Beach, Calif. “Certain types have a FICA exemption.”
For example, employees with a B-1 temporary business visitor visa cannot be on a U.S. payroll but generally are subject to Federal Insurance Contributions Act withholding, including Social Security tax and Medicare tax, Mayo said.
Nonresident employees generally are subject not only to FICA taxes and Federal Unemployment Tax Act taxes in the same manner as U.S. resident employees, but for U.S.-source income also generally are subject to federal income tax withholding based on the same withholding brackets as are applicable to U.S. residents, Mayo said. However, federal income tax withholding of nonresidents, unlike federal income tax withholding of residents, involves adding an amount to nonresidents’ actual wages for calculating income tax withholding, with the applicable amounts for various types of payroll periods available in Bloomberg Tax’s Nonresident Alien Withholding chapter.
Payments to employees who are nonresidents working in the U.S. under an F-1 academic student visa, a J-1 exchange visitor visa, an M-1 vocational student visa, or a Q-1 cultural exchange visa generally are exempt from withholding of Social Security and Medicare taxes unless they have fulfilled the substantial presence test and are not exempt from U.S. social taxation under a totalization agreement, Mayo said.
Under the substantial presence test, a nonresident is treated as a U.S. resident for federal income and social tax purposes during the current year–-and the Social Security and Medicare exemptions under the F, J, M, and Q visas therefore would be inapplicable–-if the nonresident fulfills two thresholds based on days of presence in the U.S.
The first threshold is that the nonresident is physically present in the U.S. during at least 31 days of the current year. The second threshold is that the sum of the total number of days the nonresident was present in the U.S. during the current year, one-third of the number of days the nonresident was present in the U.S. during the previous year, and one-sixth of the number of days the nonresident was present in the U.S. during the second-most recent year before the current calendar year is at least 183 days.
However, a nonresident who fulfills the substantial presence test for the current year still may be treated as a nonresident for federal tax purposes for the year if during the year the nonresident is present in the U.S. for fewer than 183 days, maintains a tax home in a foreign country, and has a closer connection to the foreign country than to the U.S., Mayo said.
If a nonresident employee working in the U.S. on an F, J, M, or Q visa fulfilled the substantial presence test for a year but the payroll department was unaware that the substantial presence test had been fulfilled and that employee and employer portions of Social Security and Medicare taxes therefore were not being paid that were required to be paid, the payroll department must work to correct the situation, Mayo said.
A Form W-2c, Corrected Wage and Tax Statement, would need to be issued to document adjustments to the nonresident employee’s tax owed, and if the employer seeks to recover the Social Security and Medicare tax underpayments from the employee, the employer would need to be cognizant of differences among states’ laws and regulations regarding the degree that employees’ tax underpayments may be recovered from employees, she said.
As a nonresident employee’s days of presence in the U.S. that are relevant for the substantial presence test often include days before the nonresident started employment with the nonresident’s current employer, payroll departments may benefit from implementing proactive measures to acquire data that would help with tracking when a nonresident employee has fulfilled the substantial presence test, Mayo said.
Better communication with the human resources department may allow greater access to relevant data as to when a nonresident employee fulfills the substantial presence test, Mayo said. Additionally, the payroll department often may require new hires to provide data at the time of hire confirming the visa with which they were authorized to work in the U.S. and the dates when they were in the U.S. during the last three years, she said.
“Payroll departments have the right to ask them for this data because it affects their taxation,” Mayo said.
If a nonresident employee would be subject to Social Security and Medicare taxes but the nonresident’s home country has a totalization agreement with the U.S. to avoid double social taxation and the nonresident has a valid certificate of coverage from the home country’s social tax agency affirming that the home country’s social tax system applies to the employee, the nonresident would not be subject to Social Security and Medicare taxes and the payroll department would need to calculate social taxation on the nonresident’s employment income based on the home country’s social tax provisions and remit the taxes to the home country’s social tax agency, Mayo said.
The U.S. has bilateral totalization agreements with Australia, Austria, Belgium, Brazil, Canada, Chile, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Luxembourg, the Netherlands, Norway, Poland, Portugal, Slovakia, Slovenia, South Korea, Spain, Sweden, Switzerland, the United Kingdom, and Uruguay.
With regard to federal income taxation, nonresident employees who are students working in the U.S. under an F, J, M, or Q visa may be exempt from withholding or subject to a reduced withholding rate of 14%, Mayo said.
Nonresident employees providing a Form W-4, Employee’s Withholding Allowance Certificate, must indicate that they are single regardless of whether they are married; they may claim only one withholding allowance unless they are a resident of Canada, Mexico, Japan, or South Korea; and they cannot claim exemption from withholding using the form, Mayo said.
However, if the U.S. has an income tax treaty with the nonresident employee’s home country and the employment conditions of the nonresident employee fulfill eligibility for reduced U.S. income taxation or exemption from U.S. income taxation, the nonresident employee may claim the reduced income tax withholding rate or exemption from income tax withholding by filing Form 8233, Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual.
To maintain the reduced withholding rate or exemption from withholding under an income tax treaty, a nonresident employee must annually file Form 8233 with the employer, and the employer must submit a copy of the form to the Internal Revenue Service within five days of accepting the form, Mayo said.
More information regarding taxation of nonresident employees working in the U.S. is available in Bloomberg Tax’s chapter on Tax Aspects of Alien Employment and Bloomberg Tax’s chapter on FICA Exemptions for Nonimmigrant Visa Holders.