The Taxation of Capital Gains of Nonresident Alien Students, Scholars and Employees of Foreign Governments
The capital gains income of nonresident alien students, scholars, and employees of foreign governments and international organizations may be taxed in a different way than the capital gains income of other nonresident aliens.
The following discussion assumes that the capital gains in question are not effectively connected with the conduct of a trade or business in the United States.
Under the residency rules of Internal Revenue Code (IRC) section 7701(b) most foreign students, foreign scholars, and alien employees of foreign governments and of international organizations in the United States are considered to be "exempt individuals." That is, they are exempt for extended periods of time from counting days of presence in the United States for the purposes of determining whether they are resident aliens of the United States. Thus, most foreign students, foreign scholars, and the alien employees of foreign governments and of international organizations in the United States remain nonresident aliens in the United States for extended periods of time. Many of these nonresident aliens make personal investments in the United States which generate income from capital gains.
IRC section 871(a)(2) imposes a flat tax of 30 percent on U.S. source capital gains in the hands of nonresident alien individuals physically present in the United States for 183 days or more during the taxable year. This 183-day rule bears no relation to the 183-day rule under the substantial presence test of IRC section 7701(b)(3). Thus, there are situations in which the 183-day rule of IRC section 871(a)(2) may apply to individuals who have not crossed the threshold of U.S. residency under IRC section 7701(b)(3). For example, a foreign diplomat, consular officer, or other nonresident alien employee of a foreign government, or nonresident alien employee of an international organization, who is visiting the United States in A or G nonimmigrant status for a period longer than 183 days in a calendar year would be subject to the 30 percent tax imposed by IRC section 871(a)(2) on his/her U.S. source capital gains - even if he/she continues to be a nonresident alien per the “exempt individual” rules under the substantial presence test of IRC section 7701(b)(3). The same rule applies to a foreign student or scholar visiting the United States in F, J, M, or Q nonimmigrant status whose presence in the United States equals or exceeds 183 days in any calendar year.
Because IRC section 871(a)(2) applies only to U.S. source capital gains, the sourcing rules of IRC section 865 must be considered when addressing the application of the 183-day rule under IRC section 871(a)(2). For the sourcing of capital gains by nonresident aliens, per IRC section 865(g)(1), gain or loss from the sale or exchange of personal property generally has its source in the United States if the alien has a tax home in the United States. Per IRC section 865(g)(1), the key factor in determining if an individual is a U.S. resident for purposes of the sourcing of capital gains is whether the alien's "tax home" has shifted to the United States. If an alien does not have a tax home in the United States, then the alien’s U.S. source capital gains would be treated as foreign-source and thus nontaxable. Here again, this provision bears no relation to the substantial presence test of IRC 7701(b)(3). We must rely upon the tax home rules of IRC sections 162(a)(2), 911(d)(3), Revenue Ruling 93-86, and Revenue Procedure 2005-10 (scheduled to be periodically updated).
In general, under the "tax home" rules, a person who is away (or who intends to be away) from his tax home for longer than 1 year has shifted tax homes to his new location upon his arrival in that new location. Thus, under this rule, most foreign students and scholars and most alien employees of foreign governments and of international organizations have shifted tax homes to the United States on the day of their arrival in the United States - unless the particular program or employment which brings them to the United States clearly terminates in less than one year and they have no intention to remain in the United States after the termination of such program or employment.
Nonresident alien students and scholars and alien employees of foreign governments and international organizations who, at the time of their arrival in the United States, intend to reside in the United States for longer than 1 year are subject to the 30 percent taxation on their capital gains during any tax year (usually calendar year) in which they are present in the United States for 183 days or more, unless a tax treaty provides for a lesser rate of taxation. This assumes that such capital gains are not effectively connected with the conduct of a United States trade or business. These capital gains would be reported on page 4 (not page 1) of Form 1040NR and would not be reported on a Schedule D because they are being taxed at a flat rate of 30 percent under IRC section 871(a) or at a reduced flat rate under a tax treaty..
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