Tax & Accounting Blog

Employing Foreign Nationals – Tax and Withholding Implications

CS Professional Suite Accounting & Auditing Solutions, CS Professional Suite Payroll Solutions, CS Tax & Asset Management Solutions August 1, 2013

Having to run payroll for foreign nationals seems like a remote possibility for most payroll service providers. And it’s true that only 14% of Thomson Reuters tax and accounting software users who process payroll reported paying foreign nationals in a recent survey.

But payroll is a fluid business. Your client could hire a foreign national tomorrow, and you’d need to be prepared. I’ve found that it pays to think about situations like this before they happen.

As a rule of thumb, foreign nationals who are employed in the United States as employees are liable for federal and state income taxes. Usually, they’re also liable for U.S. Social Security and Medicare taxes, or FICA, unless a tax treaty or Social Security agreement applies and special procedures are followed.

However, there are exceptions. Generally, foreign national employees must meet three key criteria in order to be exempt from FICA:

  1. Their employment with your company must be authorized. If they don’t have proper work authorization, they cannot be FICA exempt.
  2. They must be F-1, J-1, M-1, or Q-1 (The more common F-2 and J-2 and most all other types including L-1, H-1, and TN are never FICA exempt).
  3. They must be “nonresident aliens” for tax purposes.

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Most FICA-exempt foreign nationals are only exempt for their first five years of residence. In their sixth calendar year, they become “resident aliens” for tax purposes and are no longer FICA exempt if their presence will exceed 183 days in that year.

While these rules do not apply 100% of the time, they cover the vast majority of foreign nationals. Let’s take a look at how the rules play out in a specific hypothetical situation:

Your client’s employee entered the United States as an F-1 or J-1 student for the very first time on 12/01/09. They are a non-resident alien for five years (2009, 2010, 2011, 2012, and 2013) so long as they remain either F-1 or J-1.

On 1/1/2014, you will probably need to start withholding FICA (unless you are a university, which would bring other rules into play). Other rules apply to J-1 nonstudents. The residency rules of section 7701(b) generally consider nonstudents in J-1 status as nonresidents for two calendar years out of the current seven calendar years in the United States. In their third calendar year, they become resident aliens and are then liable for FICA taxes if their presence will exceed 183 days in that year.

It’s also important to note that yet another set of rules applies to foreign nationals who have made two or more visits to the United States in F, J, M, or Q status. These employees will become resident aliens sooner and will lose their FICA exemption.

There are also a number of immigration and tax treaty rules and procedures that you’ll need to understand and consider to make sure that you’re properly accepting the services of foreign nationals and taxing them appropriately. It’s not a simple thing, but there are tools that can help you keep up.

ONESOURCE offers a guide with more in-depth information, which is available for purchase here:

ONESOURCE Nonresident Alien Taxation

Thomson Reuters also offers a series of webcasts on nonresident alien taxation. Each webcast includes a great deal of useful information on the areas that directly affect wage payments, scholarships and fellowship grants, and fees for independent services paid to foreign nationals, including 1042/1042-S reporting, NRA withholding, tax treaty analysis, and the interrelated immigration rules.

Visit http://tax.thomsonreuters.com/resources/training/onesource/onesource-nra-tax-reporting/ for the complete schedule and to register for any upcoming webcast.

I’ve also put together a chart that provides an overview of most taxations, below.

LEGEND:
EX = exempt
FIT = Federal Income Tax withholding
SIT = State Income Tax withholding
SUTA = State Unemployment
FUTA = Federal Unemployment

Note that only salaries paid to A-status diplomats and consular officers and G-status international organization employees by their sponsoring organization for their official duties are exempt from federal and state income tax and FICA tax under special tax code rules.

TYPE OF VISA

FICA

FIT

SIT

SUTA

FUTA

A-1,
A-2

(Diplomats and Foreign Government Officials)

EX

TAX

TAX

TAX

EX

B-1

(Business)

Not allowed to work in
the US

B-2

(Tourist)

Not allowed to work in the US

C-1

(Transit Aliens)

Not allowed to work in the US

D-1

(Foreign Transport Company)

EX

EX

EX

EX

EX

(US Transport Company)

TAX

TAX

TAX

TAX

TAX

E-1

(Treaty Trader)

TAX

TAX

TAX

TAX

TAX

E-2

(Treaty Investor)

TAX

TAX

TAX

TAX

TAX

E-3

(Australian Nationals)

TAX

TAX

TAX

TAX

TAX

F-1,
J-1,
M-1

(Student Up to 5 Years)

EX

TAX

TAX

TAX

EX

(Teacher/Trainee Up to 2 Years)

EX

TAX

TAX

TAX

EX

G-1,
G-2,
G-3,
G-4

(International Organization)

EX

TAX

TAX

TAX

EX

H-1 A&B

(Nurses/Professionals)

TAX

TAX

TAX

TAX

TAX

H-2 A&B

(Temporary Agricultural/Skilled)

TAX

TAX

TAX

TAX

TAX

H-3

(Trainees)

TAX

TAX

TAX

TAX

TAX

I

(Foreign Correspondents)

TAX

TAX

TAX

TAX

TAX

L-1

(Intracompany Transfers)

TAX

TAX

TAX

TAX

TAX

O-1

(Extraordinary Ability)

TAX

TAX

TAX

TAX

TAX

O-2

(Assistant to O-1 Above)

TAX

TAX

TAX

TAX

TAX

P-1,
P-2,
P-3

(Entertainers & Athletes)

TAX

TAX

TAX

TAX

TAX

Q-1,
Q-2

(Cultural Exchange Visitors – Students Up to 5 Years)

EX

TAX

TAX

TAX

EX

(Cultural Exchange Visitors – Teacher/ Trainee Up to 2 Years)

EX

TAX

TAX

TAX

EX

R-1

(Religious Occupations – only those employed by the religious organization that sponsored them)

EX

TAX

TAX

TAX

EX

TN

(NAFTA Professionals)

TAX

TAX

TAX

TAX

TAX

For more information on taxation of visa individuals, please refer to this IRS website: http://www.irs.gov/Individuals/International-Taxpayers/Taxation-of-Nonresident-Aliens