4.   How Income of Aliens Is Taxed

Introduction

Resident and nonresident aliens are taxed in different ways. Resident aliens are generally taxed in the same way as U.S. citizens. Nonresident aliens are taxed based on the source of their income and whether or not their income is effectively connected with a U.S. trade or business. The following discussions will help you determine if income you receive during the tax year is effectively connected with a U.S. trade or business and how it is taxed.

Topics - This chapter discusses:

  • Income that is effectively connected with a U.S. trade or business.

  • Income that is not effectively connected with a U.S. trade or business.

  • Interrupted period of residence.

  • Expatriation tax.

Useful Items - You may want to see:

Publication

  • 544 Sales and Other Dispositions of Assets

  • 1212 List of Original Issue Discount Instruments

Form (and Instructions)

  • 6251 Alternative Minimum Tax—Individuals

  • Schedule D (Form 1040) Capital Gains and Losses

See chapter 12 for information about getting these publications and forms.

Resident Aliens

Resident aliens are generally taxed in the same way as U.S. citizens. This means that their worldwide income is subject to U.S. tax and must be reported on their U.S. tax return. Income of resident aliens is subject to the graduated tax rates that apply to U.S. citizens. Resident aliens use the Tax Table or Tax Computation Worksheets located in the Form 1040 instructions, which apply to U.S. citizens.

Nonresident Aliens

A nonresident alien's income that is subject to U.S. income tax must be divided into two categories:

  1. Income that is effectively connected with a trade or business in the United States, and

  2. Income that is not effectively connected with a trade or business in the United States (discussed under The 30% Tax, later).

The difference between these two categories is that effectively connected income, after allowable deductions, is taxed at graduated rates. These are the same rates that apply to U.S. citizens and residents. Income that is not effectively connected is taxed at a flat 30% (or lower treaty) rate.

If you were formerly a U.S. citizen or resident alien, these rules may not apply. See Expatriation Tax, later, in this chapter.

Trade or Business in the United States

Generally, you must be engaged in a trade or business during the tax year to be able to treat income received in that year as effectively connected with that trade or business. Whether you are engaged in a trade or business in the United States depends on the nature of your activities. The discussions that follow will help you determine whether you are engaged in a trade or business in the United States.

Personal Services

If you perform personal services in the United States at any time during the tax year, you usually are considered engaged in a trade or business in the United States.

Certain compensation paid to a nonresident alien by a foreign employer is not included in gross income. For more information, see Services Performed for Foreign Employer in chapter 3.

Other Trade or Business Activities

Other examples of being engaged in a trade or business in the United States follow.

Students and trainees.   You are considered engaged in a trade or business in the United States if you are temporarily present in the United States as a nonimmigrant under an “F,” “J,” “M,” or “Q” visa. A nonresident alien temporarily present in the United States under a “J” visa includes a nonresident alien individual admitted to the United States as an exchange visitor under the Mutual Educational and Cultural Exchange Act of 1961. The taxable part of any scholarship or fellowship grant that is U.S. source income is treated as effectively connected with a trade or business in the United States.

Business operations.   If you own and operate a business in the United States selling services, products, or merchandise, you are, with certain exceptions, engaged in a trade or business in the United States.

Partnerships.   If you are a member of a partnership that at any time during the tax year is engaged in a trade or business in the United States, you are considered to be engaged in a trade or business in the United States.

Beneficiary of an estate or trust.   If you are the beneficiary of an estate or trust that is engaged in a trade or business in the United States, you are treated as being engaged in the same trade or business.

Trading in stocks, securities, and commodities.   If your only U.S. business activity is trading in stocks, securities, or commodities (including hedging transactions) through a U.S. resident broker or other agent, you are not engaged in a trade or business in the United States.

  For transactions in stocks or securities, this applies to any nonresident alien, including a dealer or broker in stocks and securities.

  For transactions in commodities, this applies to commodities that are usually traded on an organized commodity exchange and to transactions that are usually carried out at such an exchange.

  This discussion does not apply if you have a U.S. office or other fixed place of business at any time during the tax year through which, or by the direction of which, you carry out your transactions in stocks, securities, or commodities.

Trading for a nonresident alien's own account.   You are not engaged in a trade or business in the United States if trading for your own account in stocks, securities, or commodities is your only U.S. business activity. This applies even if the trading takes place while you are present in the United States or is done by your employee or your broker or other agent.

  This does not apply to trading for your own account if you are a dealer in stocks, securities, or commodities. This does not necessarily mean, however, that as a dealer you are considered to be engaged in a trade or business in the United States. Determine that based on the facts and circumstances in each case or under the rules given above in Trading in stocks, securities, and commodities .

Effectively Connected Income

If you are engaged in a U.S. trade or business, all income, gain, or loss for the tax year that you get from sources within the United States (other than certain investment income) is treated as effectively connected income. This applies whether or not there is any connection between the income and the trade or business being carried on in the United States during the tax year.

Two tests, described next under Investment Income, determine whether certain items of investment income (such as interest, dividends, and royalties) are treated as effectively connected with that business.

In limited circumstances, some kinds of foreign source income may be treated as effectively connected with a trade or business in the United States. For a discussion of these rules, see Foreign Income , later.

Investment Income

Investment income from U.S. sources that may or may not be treated as effectively connected with a U.S. trade or business generally falls into the following three categories.

  1. Fixed or determinable income (interest, dividends, rents, royalties, premiums, annuities, etc.).

  2. Gains (some of which are considered capital gains) from the sale or exchange of the following types of property.

    1. Timber, coal, or domestic iron ore with a retained economic interest.

    2. Patents, copyrights, and similar property on which you receive contingent payments after October 4, 1966.

    3. Patents transferred before October 5, 1966.

    4. Original issue discount obligations.

  3. Capital gains (and losses).

Use the two tests, described next, to determine whether an item of U.S. source income falling in one of the three categories above and received during the tax year is effectively connected with your U.S. trade or business. If the tests indicate that the item of income is effectively connected, you must include it with your other effectively connected income. If the item of income is not effectively connected, include it with all other income discussed under The 30% Tax later, in this chapter.

Asset-use test.   This test usually applies to income that is not directly produced by trade or business activities. Under this test, if an item of income is from assets (property) used in, or held for use in, the trade or business in the United States, it is considered effectively connected.

  An asset is used in, or held for use in, the trade or business in the United States if the asset is:
  • Held for the principal purpose of promoting the conduct of a trade or business in the United States,

  • Acquired and held in the ordinary course of the trade or business conducted in the United States (for example, an account receivable or note receivable arising from that trade or business), or

  • Otherwise held to meet the present needs of the trade or business in the United States and not its anticipated future needs.

Generally, stock of a corporation is not treated as an asset used in, or held for use in, a trade or business in the United States.

Business-activities test.   This test usually applies when income, gain, or loss comes directly from the active conduct of the trade or business. The business-activities test is most important when:
  • Dividends or interest are received by a dealer in stocks or securities,

  • Royalties are received in the trade or business of licensing patents or similar property, or

  • Service fees are earned by a servicing business.

Under this test, if the conduct of the U.S. trade or business was a material factor in producing the income, the income is considered effectively connected.

Personal Service Income

You usually are engaged in a U.S. trade or business when you perform personal services in the United States. Personal service income you receive in a tax year in which you are engaged in a U.S. trade or business is effectively connected with a U.S. trade or business. Income received in a year other than the year you performed the services is also effectively connected if it would have been effectively connected if received in the year you performed the services. Personal service income includes wages, salaries, commissions, fees, per diem allowances, and employee allowances and bonuses. The income may be paid to you in the form of cash, services, or property.

If you are engaged in a U.S. trade or business only because you perform personal services in the United States during the tax year, income and gains from assets, and gains and losses from the sale or exchange of capital assets are generally not effectively connected with your trade or business. However, if there is a direct economic relationship between your holding of the asset and your trade or business of performing personal services, the income, gain, or loss is effectively connected.

Pensions.   If you were a nonresident alien engaged in a U.S. trade or business after 1986 because you performed personal services in the United States, and you later receive a pension or retirement pay attributable to these services, such payments are effectively connected income in each year you receive them. This is true whether or not you are engaged in a U.S. trade or business in the year you receive the retirement pay.

Transportation Income

Transportation income (defined in chapter 2) is effectively connected if you meet both of the following conditions.

  1. You had a fixed place of business in the United States involved in earning the income.

  2. At least 90% of your U.S. source transportation income is attributable to regularly scheduled transportation.

Fixed place of business” generally means a place, site, structure, or other similar facility through which you engage in a trade or business. “Regularly scheduled transportation” means that a ship or aircraft follows a published schedule with repeated sailings or flights at regular intervals between the same points for voyages or flights that begin or end in the United States. This definition applies to both scheduled and chartered air transportation.

If you do not meet the two conditions above, the income is not effectively connected and is taxed at a 4% rate. See Transportation Tax, later, in this chapter.

Business Profits and Losses and Sales Transactions

All profits or losses from U.S. sources that are from the operation of a business in the United States are effectively connected with a trade or business in the United States. For example, profit from the sale in the United States of inventory property purchased either in this country or in a foreign country is effectively connected trade or business income. A share of U.S. source profits or losses of a partnership that is engaged in a trade or business in the United States is also effectively connected with a trade or business in the United States.

Real Property Gain or Loss

Gains and losses from the sale or exchange of U.S. real property interests (whether or not they are capital assets) are taxed as if you are engaged in a trade or business in the United States. You must treat the gain or loss as effectively connected with that trade or business.

U.S. real property interest.   This is any interest in real property located in the United States or the U.S. Virgin Islands or any interest (other than as a creditor) in a domestic corporation that is a U.S. real property holding corporation. Real property includes the following.
  1. Land and unsevered natural products of the land, such as growing crops and timber, and mines, wells, and other natural deposits.

  2. Improvements on land, including buildings, other permanent structures, and their structural components.

  3. Personal property associated with the use of real property, such as equipment used in farming, mining, forestry, or construction or property used in lodging facilities or rented office space, unless the personal property is:

    1. Disposed of more than one year before or after the disposition of the real property, or

    2. Separately sold to persons unrelated either to the seller or to the buyer of the real property.

U.S. real property holding corporation.   A corporation is a U.S. real property holding corporation if the fair market value of the corporation's U.S. real property interests are at least 50% of the total fair market value of:
  • The corporation's U.S. real property interests, plus

  • The corporation's interests in real property located outside the United States, plus

  • The corporation's other assets that are used in, or held for use in, a trade or business.

  Gain or loss on the sale of the stock in any domestic corporation is taxed as if you are engaged in a U.S. trade or business unless you establish that the corporation is not a U.S. real property holding corporation.

  A U.S. real property interest does not include a class of stock of a corporation that is regularly traded on an established securities market, unless you hold more than 5% of the fair market value of that class of stock. An interest in a foreign corporation owning U.S. real property generally is not a U.S. real property interest unless the corporation chooses to be treated as a domestic corporation.

Qualified investment entities.   Special rules apply to qualified investment entities (QIEs). A QIE is any real estate investment trust (REIT) or any regulated investment company (RIC) that is a U.S. real property holding corporation.

   Generally, any distribution from a QIE to a shareholder that is attributable to gain from the sale or exchange of a U.S. real property interest is treated as a U.S. real property gain by the shareholder receiving the distribution. A distribution by a QIE on stock regularly traded on an established securities market in the United States is not treated as gain from the sale or exchange of a U.S. real property interest if you did not own more than 5% of that stock at any time during the 1-year period ending on the date of the distribution. A distribution that you do not treat as gain from the sale or exchange of a U.S. real property interest is included in your gross income as a regular dividend.

Note.

Beginning January 1, 2014 (unless extended by legislation), a RIC that is a U.S. real property holding corporation will only be treated as a QIE for certain distributions from the RIC that are directly or indirectly attributable to distributions received by the RIC from a REIT.

Domestically controlled QIE.   The sale of an interest in a domestically controlled QIE is not the sale of a U.S. real property interest. The entity is domestically controlled if at all times during the testing period less than 50% in value of its stock was held, directly or indirectly, by foreign persons. The testing period is the shorter of (a) the 5-year period ending on the date of disposition, or (b) the period during which the entity was in existence.

Wash sale.    If you dispose of an interest in a domestically controlled QIE in an applicable wash sale transaction, special rules apply. An applicable wash sale transaction is one in which you:
  1. Dispose of an interest in the domestically controlled QIE during the 30-day period before the ex-dividend date of a distribution that you would (but for the disposition) have treated as gain from the sale or exchange of a U.S. real property interest, and

  2. Acquire, or enter into a contract or option to acquire, a substantially identical interest in that entity during the 61-day period that began on the first day of the 30-day period.

If this occurs, you are treated as having gain from the sale or exchange of a U.S. real property interest in an amount equal to the distribution made after June 15, 2006, that would have been treated as such gain. This also applies to any substitute dividend payment.

  A transaction is not treated as an applicable wash sale transaction if:
  • You actually receive the distribution from the domestically controlled QIE related to the interest disposed of, or acquired, in the transaction, or

  • You dispose of any class of stock in a QIE that is regularly traded on an established securities market in the United States but only if you did not own more than 5% of that class of stock at any time during the 1-year period ending on the date of the distribution.

Alternative minimum tax.   There may be a minimum tax on your net gain from the disposition of U.S. real property interests. Figure the amount of this tax, if any, on Form 6251.

Withholding of tax.   If you dispose of a U.S. real property interest, the buyer may have to withhold tax. See the discussion of Tax Withheld on Real Property Sales in chapter 8.

Foreign Income

You must treat three kinds of foreign source income as effectively connected with a trade or business in the United States if:

  • You have an office or other fixed place of business in the United States to which the income can be attributed,

  • That office or place of business is a material factor in producing the income, and

  • The income is produced in the ordinary course of the trade or business carried on through that office or other fixed place of business.

An office or other fixed place of business is a material factor if it significantly contributes to, and is an essential economic element in, the earning of the income.

The three kinds of foreign source income are listed below.

  1. Rents and royalties for the use of, or for the privilege of using, intangible personal property located outside the United States or from any interest in such property. Included are rents or royalties for the use, or for the privilege of using, outside the United States, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and similar properties if the rents or royalties are from the active conduct of a trade or business in the United States.

  2. Dividends, interest, or amounts received for the provision of a guarantee of indebtedness issued after September 27, 2010, from the active conduct of a banking, financing, or similar business in the United States. A substitute dividend or interest payment received under a securities lending transaction or a sale-repurchase transaction is treated the same as the amounts received on the transferred security.

  3. Income, gain, or loss from the sale outside the United States, through the U.S. office or other fixed place of business, of:

    1. Stock in trade,

    2. Property that would be included in inventory if on hand at the end of the tax year, or

    3. Property held primarily for sale to customers in the ordinary course of business.

    Item (3) will not apply if you sold the property for use, consumption, or disposition outside the United States and an office or other fixed place of business in a foreign country was a material factor in the sale.

Any foreign source income that is equivalent to any item of income described above is treated as effectively connected with a U.S. trade or business. For example, foreign source interest and dividend equivalents are treated as U.S. effectively connected income if the income is derived by a foreign person in the active conduct of a banking, financing, or similar business within the United States.

Tax on Effectively Connected Income

Income you receive during the tax year that is effectively connected with your trade or business in the United States is, after allowable deductions, taxed at the rates that apply to U.S. citizens and residents.

Generally, you can receive effectively connected income only if you are a nonresident alien engaged in trade or business in the United States during the tax year. However, income you receive from the sale or exchange of property, the performance of services, or any other transaction in another tax year is treated as effectively connected in that year if it would have been effectively connected in the year the transaction took place or you performed the services.

Example.

Ted Richards, a nonresident alien, entered the United States in August 2012, to perform personal services in the U.S. office of his overseas employer. He worked in the U.S. office until December 25, 2012, but did not leave this country until January 11, 2013. On January 8, 2013, he received his final paycheck for services performed in the United States during 2012. All of Ted's income during his stay here is U.S. source income.

During 2012, Ted was engaged in the trade or business of performing personal services in the United States. Therefore, all amounts paid to him in 2012 for services performed in the United States during 2012 are effectively connected with that trade or business during 2012.

The salary payment Ted received in January 2013 is U.S. source income to him in 2013. It is effectively connected with a trade or business in the United States because he was engaged in a trade or business in the United States during 2012 when he performed the services that earned the income.

Real property income.   You may be able to choose to treat all income from real property as effectively connected. See Income From Real Property , later, in this chapter.

The 30% Tax

Tax at a 30% (or lower treaty) rate applies to certain items of income or gains from U.S. sources but only if the items are not effectively connected with your U.S. trade or business.

Fixed or Determinable Income

The 30% (or lower treaty) rate applies to the gross amount of U.S. source fixed or determinable annual or periodic gains, profits, or income.

Income is fixed when it is paid in amounts known ahead of time. Income is determinable whenever there is a basis for figuring the amount to be paid. Income can be periodic if it is paid from time to time. It does not have to be paid annually or at regular intervals. Income can be determinable or periodic even if the length of time during which the payments are made is increased or decreased.

Items specifically included as fixed or determinable income are interest (other than original issue discount), dividends, dividend equivalent payments (defined in chapter 2), rents, premiums, annuities, salaries, wages, and other compensation. A substitute dividend or interest payment received under a securities lending transaction or a sale-repurchase transaction is treated the same as the amounts received on the transferred security. Other items of income, such as royalties, also may be subject to the 30% tax.

Some fixed or determinable income may be exempt from U.S. tax. See chapter 3 if you are not sure whether the income is taxable.

Original issue discount (OID).   If you sold, exchanged, or received a payment on a bond or other debt instrument that was issued at a discount after March 31, 1972, all or part of the original issue discount (OID) (other than portfolio interest) may be subject to the 30% tax. The amount of OID is the difference between the stated redemption price at maturity and the issue price of the debt instrument. The 30% tax applies in the following circumstances.
  1. You received a payment on a debt instrument. In this case, the amount of OID subject to tax is the OID that accrued while you held the debt instrument minus the OID previously taken into account. But the tax on the OID cannot be more than the payment minus the tax on the interest payment on the debt instrument.

  2. You sold or exchanged the debt instrument. The amount of OID subject to tax is the OID that accrued while you held the debt instrument minus the amount already taxed in (1) above.

  Report on your return the amount of OID shown on Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, if you bought the debt instrument at original issue. However, you must recompute your proper share of OID shown on Form 1042-S if any of the following apply.
  • You bought the debt instrument at a premium or paid an acquisition premium.

  • The debt instrument is a stripped bond or a stripped coupon (including zero coupon instruments backed by U.S. Treasury securities).

  • The debt instrument is a contingent payment or inflation-indexed debt instrument.

For the definition of premium and acquisition premium and instructions on how to recompute OID, get Publication 1212.

  If you held a bond or other debt instrument that was issued at a discount before April 1, 1972, contact the IRS for further information. See chapter 12.

Gambling Winnings

In general, nonresident aliens are subject to the 30% tax on the gross proceeds from gambling won in the United States if that income is not effectively connected with a U.S. trade or business and is not exempted by treaty. However, no tax is imposed on nonbusiness gambling income a nonresident alien wins playing blackjack, baccarat, craps, roulette, or big-6 wheel in the United States.

Nonresident aliens are taxed at graduated rates on net gambling income won in the United States that is effectively connected with a U.S. trade or business.

Social Security Benefits

A nonresident alien must include 85% of any U.S. social security benefit (and the social security equivalent part of a tier 1 railroad retirement benefit) in U.S. source fixed or determinable annual or periodic income. Social security benefits include monthly retirement, survivor, and disability benefits. This income is exempt under some tax treaties. See Table 1 in Publication 901, U.S. Tax Treaties, for a list of tax treaties that exempt U.S. social security benefits from U.S. tax.

Sales or Exchanges of Capital Assets

These rules apply only to those capital gains and losses from sources in the United States that are not effectively connected with a trade or business in the United States. They apply even if you are engaged in a trade or business in the United States. These rules do not apply to the sale or exchange of a U.S. real property interest or to the sale of any property that is effectively connected with a trade or business in the United States. See Real Property Gain or Loss , earlier, under Effectively Connected Income.

A capital asset is everything you own except:

  • Inventory.

  • Business accounts or notes receivable.

  • Depreciable property used in a trade or business.

  • Real property used in a trade or business.

  • Supplies regularly used in a trade or business.

  • Certain copyrights, literary or musical or artistic compositions, letters or memoranda, or similar property.

  • Certain U.S. government publications.

  • Certain commodities derivative financial instruments held by a commodities derivatives dealer.

  • Hedging transactions.

A capital gain is a gain on the sale or exchange of a capital asset. A capital loss is a loss on the sale or exchange of a capital asset.

If the sale is in foreign currency, for the purpose of determining gain, the cost and selling price of the property should be expressed in U.S. currency at the rate of exchange prevailing as of the date of the purchase and date of the sale, respectively.

You may want to read Publication 544. However, use Publication 544 only to determine what is a sale or exchange of a capital asset, or what is treated as such. Specific tax treatment that applies to U.S. citizens or residents generally does not apply to you.

The following gains are subject to the 30% (or lower treaty) rate without regard to the 183-day rule, discussed later.

  1. Gains on the disposal of timber, coal, or domestic iron ore with a retained economic interest.

  2. Gains on contingent payments received from the sale or exchange of patents, copyrights, and similar property after October 4, 1966.

  3. Gains on certain transfers of all substantial rights to, or an undivided interest in, patents if the transfers were made before October 5, 1966.

  4. Gains on the sale or exchange of original issue discount obligations.

Gains in (1) are not subject to the 30% (or lower treaty) rate if you choose to treat the gains as effectively connected with a U.S. trade or business. See Income From Real Property , later.

183-day rule.   If you were in the United States for 183 days or more during the tax year, your net gain from sales or exchanges of capital assets is taxed at a 30% (or lower treaty) rate. For purposes of the 30% (or lower treaty) rate, net gain is the excess of your capital gains from U.S. sources over your capital losses from U.S. sources. This rule applies even if any of the transactions occurred while you were not in the United States.

  To determine your net gain, consider the amount of your gains and losses that would be recognized and taken into account only if, and to the extent that, they would be recognized and taken into account if you were in a U.S. trade or business during the year and the gains and losses were effectively connected with that trade or business during the tax year.

  In arriving at your net gain, do not take the following into consideration.
  • The four types of gains listed earlier.

  • The deduction for a capital loss carryover.

  • Capital losses in excess of capital gains.

  • Exclusion for gain from the sale or exchange of qualified small business stock (section 1202 exclusion).

  • Losses from the sale or exchange of property held for personal use. However, losses resulting from casualties or thefts may be deductible on Schedule A (Form 1040NR). See Itemized Deductions in chapter 5.

  If you are not engaged in a trade or business in the United States and have not established a tax year for a prior period, your tax year will be the calendar year for purposes of the 183-day rule. Also, you must file your tax return on a calendar-year basis.

  If you were in the United States for less than 183 days during the tax year, capital gains (other than gains listed earlier) are tax exempt unless they are effectively connected with a trade or business in the United States during your tax year.

Reporting.   Report your gains and losses from the sales or exchanges of capital assets that are not effectively connected with a trade or business in the United States on page 4 of Form 1040NR. Report gains and losses from sales or exchanges of capital assets (including real property) that are effectively connected with a trade or business in the United States on a separate Schedule D (Form 1040), Form 4797, or both. Attach them to Form 1040NR.

Income From Real Property

If you have income from real property located in the United States that you own or have an interest in and hold for the production of income, you can choose to treat all income from that property as income effectively connected with a trade or business in the United States. The choice applies to all income from real property located in the United States and held for the production of income and to all income from any interest in such property. This includes income from rents, royalties from mines, oil or gas wells, or other natural resources. It also includes gains from the sale or exchange of timber, coal, or domestic iron ore with a retained economic interest.

You can make this choice only for real property income that is not otherwise effectively connected with your U.S. trade or business.

If you make the choice, you can claim deductions attributable to the real property income and only your net income from real property is taxed.

This choice does not treat a nonresident alien, who is not otherwise engaged in a U.S. trade or business, as being engaged in a trade or business in the United States during the year.

Example.

You are a nonresident alien and are not engaged in a U.S. trade or business. You own a single-family house in the United States that you rent out. Your rental income for the year is $10,000. This is your only U.S. source income. As discussed earlier under The 30% Tax, the rental income is subject to a tax at a 30% (or lower treaty) rate. You received a Form 1042-S showing that your tenants properly withheld this tax from the rental income. You do not have to file a U.S. tax return (Form 1040NR) because your U.S. tax liability is satisfied by the withholding of tax.

If you make the choice discussed earlier, you can offset the $10,000 income by certain rental expenses. (See Publication 527, Residential Rental Property, for information on rental expenses.) Any resulting net income is taxed at graduated rates. If you make this choice, report the rental income and expenses on Schedule E (Form 1040) and attach the schedule to Form 1040NR. For the first year you make the choice, also attach the statement discussed next.

Making the choice.   Make the initial choice by attaching a statement to your return, or amended return, for the year of the choice. Include the following in your statement.
  • That you are making the choice.

  • Whether the choice is under Internal Revenue Code section 871(d) (explained earlier) or a tax treaty.

  • A complete list of all your real property, or any interest in real property, located in the United States. Give the legal identification of U.S. timber, coal, or iron ore in which you have an interest.

  • The extent of your ownership in the property.

  • The location of the property.

  • A description of any major improvements to the property.

  • The dates you owned the property.

  • Your income from the property.

  • Details of any previous choices and revocations of the real property income choice.

  This choice stays in effect for all later tax years unless you revoke it.

Revoking the choice.   You can revoke the choice without IRS approval by filing Form 1040X, Amended U.S. Individual Income Tax Return, for the year you made the choice and for later tax years. You must file Form 1040X within 3 years from the date your return was filed or 2 years from the time the tax was paid, whichever is later. If this time period has expired for the year of choice, you cannot revoke the choice for that year. However, you may revoke the choice for later tax years only if you have IRS approval. For information on how to get IRS approval, see Regulation section 1.871-10(d)(2).

Transportation Tax

A 4% tax rate applies to transportation income that is not effectively connected because it does not meet the two conditions listed earlier under Transportation Income . If you receive transportation income subject to the 4% tax, you should figure the tax and show it on line 57 of Form 1040NR. Attach a statement to your return that includes the following information (if applicable).

  • Your name, taxpayer identification number, and tax year.

  • A description of the types of services performed (whether on or off board).

  • Names of vessels or registration numbers of aircraft on which you performed the services.

  • Amount of U.S. source transportation income derived from each type of service for each vessel or aircraft for the calendar year.

  • Total amount of U.S. source transportation income derived from all types of services for the calendar year.

This 4% tax applies to your U.S. source gross transportation income. This only includes transportation income that is treated as derived from sources in the United States if the transportation begins or ends in the United States. For transportation income from personal services, the transportation must be between the United States and a U.S. possession. For personal services of a nonresident alien, this only applies to income derived from, or in connection with, an aircraft.

Interrupted Period of Residence

You are subject to tax under a special rule if you interrupt your period of U.S. residence with a period of nonresidence. The special rule applies if you meet all of the following conditions.

  1. You were a U.S. resident for a period that includes at least 3 consecutive calendar years.

  2. You were a U.S. resident for at least 183 days in each of those years.

  3. You ceased to be treated as a U.S. resident.

  4. You then again became a U.S. resident before the end of the third calendar year after the end of the period described in (1) above.

Under this special rule, you are subject to tax on your U.S. source gross income and gains on a net basis at the graduated rates applicable to individuals (with allowable deductions) for the period you were a nonresident alien, unless you would be subject to a higher tax under the 30% tax (discussed earlier) on income not connected with a U.S. trade or business. For information on how to figure the special tax, see How To Figure the Expatriation Tax (If You Expatriated Before June 17, 2008) under Expatriation Tax , below.

Example.

John Willow, a citizen of New Zealand, entered the United States on April 1, 2008, as a lawful permanent resident. On August 1, 2010, John ceased to be a lawful permanent resident and returned to New Zealand. During his period of residence, he was present in the United States for at least 183 days in each of three consecutive years (2008, 2009, and 2010). He returned to the United States on October 5, 2013, as a lawful permanent resident. He became a resident before the close of the third calendar year (2013) beginning after the end of his first period of residence (August 1, 2010). Therefore, he is subject to tax under the special rule for the period of nonresidence (August 2, 2010, through October 4, 2013) if it is more than the tax that would normally apply to him as a nonresident alien.

Reporting requirements.   If you are subject to this tax for any year in the period you were a nonresident alien, you must file Form 1040NR for that year. The return is due by the due date (including extensions) for filing your U.S. income tax return for the year that you again become a U.S. resident. If you already filed returns for that period, you must file amended returns. You must attach a statement to your return that identifies the source of all of your U.S. and foreign gross income and the items of income subject to this special rule.

Expatriation Tax

The expatriation tax provisions apply to U.S. citizens who have renounced their citizenship and long-term residents who have ended their residency. The rules that apply are based on the dates of expatriation, which are described in the following sections.

  • Expatriation Before June 4, 2004.

  • Expatriation After June 3, 2004, and Before June 17, 2008.

  • Expatriation After June 16, 2008.

Long-term resident defined.   You are a long-term resident if you were a lawful permanent resident of the United States in at least 8 of the last 15 tax years ending with the year your residency ends. In determining if you meet the 8-year requirement, do not count any year that you are treated as a resident of a foreign country under a tax treaty and do not waive treaty benefits.

Expatriation Before June 4, 2004

If you expatriated before June 4, 2004, the expatriation rules apply if one of the principal purposes of the action is the avoidance of U.S. taxes. Unless you received a ruling from the IRS that you did not expatriate to avoid U.S. taxes, you are presumed to have tax avoidance as a principal purpose if:

  1. Your average annual net income tax for the last 5 tax years ending before the date of your action to relinquish your citizenship or terminate your residency was more than $100,000, or

  2. Your net worth on the date of your action was $500,000 or more.

The amounts above are adjusted for inflation if your expatriation action is after 1997 (see Table 4-1).

Table 4-1. Inflation-Adjusted Amounts for Expatriation Actions Before June 4, 2004
IF you expatriated during . . .   THEN the rules outlined on this page apply if . . .
    Your 5-year average annual net income tax was more than ... OR Your net worth equaled or exceeded ...
1999   110,000   552,000
2000   112,000   562,000
2001   116,000   580,000
2002   120,000   599,000
2003   122,000   608,000
2004 (before June 4)*   124,000   622,000
*If you expatriated after June 3, 2004, see Expatriation After June 3, 2004, and Before June 17, 2008 or Expatriation After June 16, 2008.

Reporting requirements.   If you lost your U.S. citizenship, you should have filed Form 8854 with a consular office or a federal court at the time of loss of citizenship. If you ended your long-term residency, you should have filed Form 8854 with the Internal Revenue Service when you filed your dual-status tax return for the year your residency ended.

  Your U.S. residency is considered to have ended when you ceased to be a lawful permanent resident or you began to be treated as a resident of another country under a tax treaty and do not waive treaty benefits.

Penalties.   If you failed to file Form 8854, you may have to pay a penalty equal to the greater of 5% of the expatriation tax or $1,000. The penalty will be assessed for each year of the 10-year period beginning on the date of expatriation during which your failure to file continues. The penalty will not be imposed if you can show that the failure is due to reasonable cause and not willful neglect.

Expatriation tax.   The expatriation tax applies to the 10-year period following the date of expatriation or termination of residency. It is figured in the same way as for those expatriating after June 3, 2004, and before June 17, 2008. See How To Figure the Expatriation Tax (If You Expatriated Before June 17, 2008) in the next section.

Expatriation After June 3, 2004, and Before June 17, 2008

If you expatriated after June 3, 2004, and before June 17, 2008, the expatriation rules apply to you if any of the following statements apply.

  1. Your average annual net income tax for the 5 tax years ending before the date of expatriation or termination of residency is more than:

    1. $124,000 if you expatriated or terminated residency in 2004.

    2. $127,000 if you expatriated or terminated residency in 2005.

    3. $131,000 if you expatriated or terminated residency in 2006.

    4. $136,000 if you expatriated or terminated residency in 2007.

    5. $139,000 if you expatriated or terminated residency in 2008.

  2. Your net worth is $2 million or more on the date of your expatriation or termination of residency.

  3. You fail to certify on Form 8854 that you have complied with all U.S. federal tax obligations for the 5 tax years preceding the date of your expatriation or termination of residency.

Exception for dual-citizens and certain minors.   Certain dual-citizens and certain minors (defined next) are not subject to the expatriation tax even if they meet (1) or (2) earlier. However, they still must provide the certification required in (3).

Certain dual-citizens.   You may qualify for the exception described above if all of the following apply.
  • You became at birth a U.S. citizen and a citizen of another country and you continue to be a citizen of that other country.

  • You were never a resident alien of the United States (as defined in chapter 1).

  • You never held a U. S. passport.

  • You were present in the United States for no more than 30 days during any calendar year that is 1 of the 10 calendar years preceding your loss of U. S. citizenship.

Certain minors.   You may qualify for the exception described above if you meet all of the following requirements.
  • You became a U.S. citizen at birth.

  • Neither of your parents was a U.S. citizen at the time of your birth.

  • You expatriated before you were 18½.

  • You were present in the United States for not more than 30 days during any calendar year that is 1 of the 10 calendar years preceding your expatriation.

Tax consequences of presence in the United States.   The following rules apply if you do not meet the exception above for dual-citizens and certain minors and the expatriation rules would otherwise apply to you.

  The expatriation tax does not apply to any tax year during the 10-year period if you are physically present in the United States for more than 30 days during the calendar year ending in that year. Instead, you are treated as a U.S. citizen or resident and taxed on your worldwide income for that tax year. You must file Form 1040, 1040A, or 1040EZ and figure your tax as prescribed in the instructions for those forms.

  When counting the number of days of presence during a calendar year, count any day you were physically present in the United States at any time during the day. However, do not count any days (up to a limit of 30 days) on which you performed personal services in the United States for an employer who is not related to you if either of the following apply.
  1. You have ties with other countries. You have ties with other countries if:

    1. You became (within a reasonable period after your expatriation or termination of residency) a citizen or resident of the country in which you, your spouse, or either of your parents were born, and

    2. You became fully liable for income tax in that country.

  2. You were physically present in the United States for 30 days or less during each year in the 10-year period ending on the date of expatriation or termination of residency. Do not count any day you were an exempt individual or were unable to leave the United States because of a medical condition that arose while you were in the United States. See Exempt individual and Medical condition in chapter 1 under Substantial Presence Test, but disregard the information about Form 8843.

Related employer.   If your employer in the United States is any of the following, then your employer is related to you. You must count any days you performed services in the United States for that employer as days of presence in the United States.
  • Members of your family. This includes only your brothers and sisters, half-brothers and half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.).

  • A partnership in which you directly or indirectly own more than 50% of the capital interest or the profits interest.

  • A corporation in which you directly or indirectly own more than 50% in value of the outstanding stock. (See Publication 550, chapter 4, Constructive ownership of stock, for how to determine whether you directly or indirectly own outstanding stock.)

  • A tax-exempt charitable or educational organization that is directly or indirectly controlled, in any manner or by any method, by you or by a member of your family, whether or not this control is legally enforceable.

Date of tax expatriation.   For purposes of U.S. tax rules, the date of your expatriation or termination of residency is the later of the dates on which you perform the following actions.
  • You notify either the Department of State or the Department of Homeland Security (whichever is appropriate) of your expatriating act or termination of residency.

  • You file Form 8854 in accordance with the form instructions.

Annual return.   If the expatriation tax applies to you, you must file Form 8854 each year during the 10-year period following the date of expatriation. You must file this form even if you owe no U.S. tax.

Penalty.   If you fail to file Form 8854 for any tax year, fail to include all information required to be shown on the form, or include incorrect information, you may have to pay a penalty of $10,000. You will not have to pay a penalty if you show that the failure is due to reasonable cause and not to willful neglect.

How To Figure the Expatriation Tax (If You Expatriated Before June 17, 2008)

If the expatriation tax applies to you, you are generally subject to tax on your U.S. source gross income and gains on a net basis at the graduated rates applicable to individuals (with allowable deductions) unless you would be subject to a higher tax under the 30% tax (discussed earlier) on income not connected with a U.S. trade or business.

For this purpose, U.S. source gross income (defined in chapter 2) includes gains from the sale or exchange of:

  • Property (other than stock or debt obligations) located in the United States,

  • Stock issued by a U.S. domestic corporation, and

  • Debt obligations of U.S. persons or of the United States, a state or political subdivision thereof, or the District of Columbia.

U.S. source income also includes any income or gain derived from stock in certain controlled foreign corporations if you owned, or were considered to own, at any time during the 2-year period ending on the date of expatriation, more than 50% of:

  • The total combined voting power of all classes of that corporation's stock, or

  • The total value of the stock.

The income or gain is considered U.S. source income only to the extent of your share of earnings and profits earned or accumulated before the date of expatriation and during the periods you met the ownership requirements discussed above.

Any exchange of property is treated as a sale of the property at its fair market value on the date of the exchange and any gain is treated as U.S. source gross income in the tax year of the exchange unless you enter into a gain recognition agreement under Notice 97-19.

Other information.   For more information on the expatriation tax provisions, including exceptions to the tax and special U.S. source rules, see section 877 of the Internal Revenue Code.

Expatriation Tax Return

If you expatriated or terminated your U.S. residency, or you are subject to the expatriation tax, you must file Form 8854, Initial and Annual Expatriation Statement. Attach it to Form 1040NR if you are required to file that form. If you are present in the United States following your expatriation and are subject to tax as a U.S. citizen or resident, file Form 8854 with Form 1040.

Expatriation After June 16, 2008

If you expatriated after June 16, 2008, the expatriation rules apply to you if you meet any of the following conditions.

  1. Your average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than:

    1. $139,000 if you expatriated or terminated residency in 2008.

    2. $145,000 if you expatriated or terminated residency in 2009 or 2010.

    3. $147,000 if you expatriated or terminated residency in 2011.

    4. $151,000 if you expatriated or terminated residency in 2012.

    5. $155,000 if you expatriated or terminated residency in 2013.

  2. Your net worth is $2 million or more on the date of your expatriation or termination of residency.

  3. You fail to certify on Form 8854 that you have complied with all U.S. federal tax obligations for the 5 years preceding the date of your expatriation or termination of residency.

Exception for dual-citizens and certain minors.   Certain dual-citizens and certain minors (defined next) are not subject to the expatriation tax even if they meet (1) or (2) above. However, they still must provide the certification required in (3) above.

Certain dual-citizens.   You may qualify for the exception described above if both of the following apply.
  • You became at birth a U.S. citizen and a citizen of another country and you continue to be a citizen of, and are taxed as a resident of, that other country.

  • You have been a resident of the United States for not more than 10 years during the 15-year tax period ending with the tax year during which the expatriation occurs. For the purpose of determining U.S. residency, use the substantial presence test described in chapter 1.

Certain minors.   You may qualify for the exception described earlier if you meet both of the following requirements.
  • You expatriated before you were 18½.

  • You have been a resident of the United States for not more than 10 tax years before the expatriation occurs. For the purpose of determining U.S. residency, use the substantial presence test described in chapter 1.

Expatriation date.   Your expatriation date is the date you relinquish U.S. citizenship (in the case of a former citizen) or terminate your long-term residency (in the case of a former U.S. resident).

Former U.S. citizen.   You are considered to have relinquished your U.S. citizenship on the earliest of the following dates.
  1. The date you renounced U.S. citizenship before a diplomatic or consular officer of the United States (provided that the voluntary renouncement was later confirmed by the issuance of a certificate of loss of nationality).

  2. The date you furnished to the State Department a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an expatriating act (provided that the voluntary relinquishment was later confirmed by the issuance of a certificate of loss of nationality).

  3. The date the State Department issued a certificate of loss of nationality.

  4. The date that a U.S. court canceled your certificate of naturalization.

Former long-term resident.   You are considered to have terminated your long-term residency on the earliest of the following dates.
  1. The date you voluntarily relinquished your lawful permanent resident status by filing Department of Homeland Security Form I-407 with a U.S. consular or immigration officer, and the Department of Homeland Security determined that you have, in fact, abandoned your lawful permanent resident status.

  2. The date you became subject to a final administrative order for your removal from the United States under the Immigration and Nationality Act and you actually left the United States as a result of that order.

  3. If you were a dual resident of the United States and a country with which the United States has an income tax treaty, the date you began to be treated as a resident of that country and you determined that, for purposes of the treaty, you are a resident of the treaty country and notify the IRS of that treatment on Forms 8833 and 8854. See Effect of Tax Treaties in chapter 1 for more information about dual residents.

How To Figure the Expatriation Tax (If You Expatriate After June 16, 2008)

In the year you expatriate, you are subject to income tax on the net unrealized gain (or loss) in your property as if the property had been sold for its fair market value on the day before your expatriation date (“mark-to-market tax”). This applies to most types of property interests you held on the date of relinquishment of citizenship or termination of residency. But see Exceptions , later.

Gains arising from deemed sales must be taken into account for the tax year of the deemed sale without regard to other U.S. internal revenue laws. Losses from deemed sales must be taken into account to the extent otherwise provided under U.S. internal revenue laws. However, Internal Revenue Code section 1091 (relating to the disallowance of losses on wash sales of stock and securities) does not apply. The net gain that you otherwise must include in your income is reduced (but not below zero) by:

  1. $600,000 if you expatriated or terminated residency before January 1, 2009.

  2. $626,000 if you expatriated or terminated residency in 2009.

  3. $627,000 if you expatriated or terminated residency in 2010.

  4. $636,000 if you expatriated or terminated residency in 2011.

  5. $651,000 if you expatriated or terminated residency in 2012.

  6. $668,000 if you expatriated or terminated residency in 2013.

Exceptions.   The mark-to-market tax does not apply to the following.
  1. Eligible deferred compensation items.

  2. Ineligible deferred compensation items.

  3. Interests in nongrantor trusts.

  4. Specified tax deferred accounts.

Instead, items (1) and (3) may be subject to withholding at source. In the case of item (2), you are treated as receiving the present value of your accrued benefit as of the day before the expatriation date. In the case of item (4), you are treated as receiving a distribution of your entire interest in the account on the day before your expatriation date. See paragraphs (d), (e), and (f) of section 877A for more information.

Expatriation Tax Return

If you expatriated or terminated your U.S. residency, or you are subject to the expatriation rules (as discussed earlier in the first paragraph under Expatriation After June 16, 2008), you must file Form 8854. Attach it to Form 1040 or Form 1040NR if you are required to file either of those forms.

Deferral of payment of mark-to-market tax.   You can make an irrevocable election to defer payment of the mark-to-market tax imposed on the deemed sale of property. If you make this election, the following rules apply.
  1. You can make the election on a property-by-property basis.

  2. The deferred tax attributable to a particular property is due on the return for the tax year in which you dispose of the property.

  3. Interest is charged for the period the tax is deferred.

  4. The due date for the payment of the deferred tax cannot be extended beyond the earlier of the following dates.

    1. The due date of the return required for the year of death.

    2. The time that the security provided for the property fails to be adequate. See item (6) below.

  5. You make the election on Form 8854.

  6. You must provide adequate security (such as a bond).

  7. You must make an irrevocable waiver of any right under any treaty of the United States which would preclude assessment or collection of the mark-to-market tax.

  For more information about the deferral of payment, see the Instructions for Form 8854.


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