International Withholding Issues Toolkit
Federal, state and local governmental entities often act as withholding agents, and pay income to nonresident aliens. This discussion covers the following:
Persons responsible for withholding (withholding agents),
Types of income subject to withholding, and
Information return and tax return filing obligations of withholding agents
The discussion includes the rules that generally apply to payments of U.S. source income to nonresident aliens.
Withholding of Tax
Generally, a nonresident alien is subject to U.S. tax on its U.S. source income. Most types of U.S. source income received by a nonresident are subject to U.S. tax at a rate of 30%, unless a lower amount is prescribed by a tax treaty. An in-depth discussion of tax treaties is beyond the scope of this article, and we recommend reviewing Publication 901, U.S. Tax Treaties.
The tax is generally withheld from the payment made to the nonresident alien. Nonresident alien (NRA) withholding is descriptively used to refer to withholding required under section 1441 of the Internal Revenue Code. Generally, NRA withholding describes the withholding regime that requires withholding on a payment of U.S. source income.
For general information about withholding, see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.
Withholding is required at the time you make a payment of an amount subject to withholding.
You are required to report payments subject to NRA withholding on Form 1042-S and to file a tax return on Form 1042. Form 1042 is due March 15 of the following year. Note: Form 1042 has unique requirements to deposit tax; these differ from Form 941 tax deposits.
A withholding agent is the person responsible for withholding on payments made to a nonresident alien. You are a withholding agent if you have control, receipt, custody, disposal, or payment of any item of income of a nonresident alien that is subject to withholding.
Liability for tax
As a withholding agent, you are personally liable for any tax required to be withheld. This liability is independent of the tax liability of the nonresident alien to whom the payment is made. If you fail to withhold and the NRA fails to satisfy his or her U.S. tax liability, then both you and the nonresident alien are liable for tax, as well as interest and any applicable penalties. The applicable tax will be collected only once. If the nonresident alien satisfies the U.S. tax liability, you may still be held liable for interest and penalties for your failure to withhold.
Determination of amount to withhold
You must withhold on the gross amount subject to NRA withholding. You cannot reduce the gross amount by any deductions. If the determination of the source of the income or the amount subject to tax depends on facts that are not known at the time of payment, you must withhold an amount sufficient to ensure that at least 30% of the amount subsequently determined to be subject to withholding is withheld. In no case, however, should you withhold more than 30% of the total amount paid; if this is done because of error or inaccurate estimate of income, the excess should be refunded to the recipient.
Persons Subject to NRA Withholding
NRA withholding applies only to payments made to nonresident aliens. It does not apply to payments made to U.S. persons. Usually, you determine the payee’s status as a U.S. or foreign person based on the documentation that person provides.
A nonresident alien is an individual who is not a U.S. citizen or a resident alien.
A resident alien is an individual that is not a citizen or national of the United States and who meets either the green card test or the substantial presence test for the calendar year. Generally, resident aliens are taxed in the same way as U.S. citizens.
Green card test - An alien is a U.S. resident if the individual was a lawful permanent resident of the United States at any time during the calendar year. This is known as the “green card test” because these aliens hold immigrant visas (also known as “green cards”).
Substantial presence test - An alien is considered a U.S. resident if the individual meets the substantial presence test for the calendar year. Under this test, the individual must be physically present in the United States on at least:
31 days during the current calendar year, and
183 days during the current year and the 2 preceding years, counting all the days of physical presence in the current year, but only 1/3 the number of days of presence in the first preceding year, and only 1/6 the number of days in the second preceding year.
Generally, the days the alien is in the United States as a teacher, student, or trainee on an “F, J, M, or Q” visa are not counted toward the substantial presence test. This exception is for a limited period of time. A discussion of students, scholars, teachers, researchers, exchange visitors, and cultural exchange visitors temporarily in the United States on “F, J, M, or Q” visas is beyond the scope of this article. This topic is discussed in another IRS article, Foreign Students and Scholars.
For more information on resident and nonresident status, the tests for residence, and the exceptions to them, please see Publication 519, Tax Guide for Aliens.
Exceptions to 30% Withholding Rule
Generally, you must withhold 30% from the gross amount paid to a nonresident alien unless you can reliably associate the payment with valid documentation that establishes either of the following.
The payee is a U.S. person.
The payee is a nonresident alien person that is the beneficial owner of the income and is entitled to a reduced rate of withholding.
The nonresident alien may provide you with one of the following forms. They deal with various exceptions to the general withholding rules. You may link to these forms for further information. See Publication 515.
Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding
Form W-8ECI, Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States
Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Withholding
Form W-8EXP, Certificate of Foreign Government or Other Organization for United States Tax Withholding
Form 8233, Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual
Source of Income
Generally, income is from a U.S. source if it is paid for personal services rendered within the United States. This is considered U.S. sourced income. Payments to a nonresident alien for personal services rendered outside the U.S. are determined to be foreign-sourced income, and are considered non-taxable and non-reportable.
Scholarships, fellowships, and grants are sourced according to the residence of the payer. Those made by entities created or domiciled in the United States are generally treated as income from sources within the United States. Scholarship, fellowship and grant income are reportable on a Form 1042S to the nonresident alien. Those made by entities created or domiciled in a foreign country are treated as income from foreign sources, and are considered nontaxable and nonreportable.
The source of pension payments is determined by the portion of the distribution that constitutes the compensation element (employer contributions) and the portion that constitutes the earnings element (the investment income). The compensation element is sourced the same as compensation from the performance of personal services. The portion attributable to services performed in the United States is U.S. source income, and the portion attributable to services performed outside the United States is foreign source income. The earnings portion of a pension payment is U.S. source income if the trust is a U.S. trust.
The information contained in this article is not to be considered an official position of the Internal Revenue Service. If you would like to obtain official written advice on an issue, please see IRS Revenue Procedure 2014-1.