In this global economy, U.S. employers both large and small routinely employ non-U.S. citizens as well as U.S. citizens. The payroll withholding and reporting rules that apply to non-U.S. citizen employees are generally the same as for U.S. citizen employees if they are resident aliens (RAs) as that term is defined by Section 7701(b) of the Internal Revenue Code (IRC). However, withholding rules differ for non-U.S. citizen employees who are nonresident aliens (NRAs) because they do not satisfy one of the two tests for being a resident alien.
Nonresident employees are subject to special federal income tax rules. As a result, different wage withholding rules designed to approximate the tax liability of nonresident aliens apply to their wages. Also, for policy reasons, some nonresident employees are exempt from Social Security and Medicare (FICA) taxes. Wage reporting for nonresident employees is generally the same as for U.S. citizen employees with one exception. Wages exempt from withholding under an income tax treaty must be reported on a Form 1042-S, not a Form W-2. State withholding and reporting rules are based on state definitions of resident and nonresident, which vary by state. Some states’ residency definitions treat nonimmigrants, such as students, as state nonresidents (e.g., Wisconsin). State withholding and reporting rules are typically the same for U.S. citizens and non-U.S. citizens alike.
Understanding and correctly applying all the rules and procedures for making wage payments to foreign employees is more important now than ever before. Because of the international tax gap, the IRS is now focusing on compliance with international tax rules for paying foreign nationals in all sectors, for-profit and government entities as well as the tax-exempt sector, which was the IRS’ initial focus for enforcing compliance with these rules. The IRS is now aided by technical tools, such as automated notification about sponsored employees provided by the immigration service. As a result, employers should anticipate that payroll compliance audits will include audits of the organization’s application of the special payroll rules for wages paid to nonresident employees and implement policies and procedures to ensure compliance with these rules.