IRS Publication 515, Table 2, Compensation for Personal Services Performed in United States Exempt from Withholding and U.S. Income Tax Under Income Tax Treaties, assigns Income Codes to the categories of income described in the table and describes the various limitations that apply to each type of income. All of the following Income Codes described in Table 2 are assigned to individual recipients (Recipient Code 01) but see the discussion below about the assignment of Income Code 20 to entities with performance income:
15 – Scholarship or fellowship grants
16 – Compensation for independent personal services
17 – Compensation for dependent personal services
18 – Compensation for teaching
19 – Compensation during study and training
20 – Earnings as an artist or athlete
Although assignment of these codes appears to be straight forward based on their description and discussions in IRS Publication 515, there are some issues that payers must resolve on their own.
Scholarship and Fellowship Grants. Although Table 2 is named “Compensation for Personal Services,” scholarship and fellowship grants reported under Income Code 15 include only scholarships and fellowships for which no services (past, present, or future) are required to be performed in order to receive the grant. Nonresident aliens who are in the United States in F, J, M, or Q immigration status are treated as engaged in a U.S. trade or business, and any scholarship or fellowship grants that they receive are treated as ECI. Therefore, such grant recipients are required to submit a Form 1040NR or 1040NR-EZ. The return is required even if the grants are treaty-exempt or do not exceed the personal exemption amount.
Individuals in any other immigration status who are recipients of taxable scholarship or fellowship grants not exempt from tax under a tax treaty are in receipt of FDAPI and have no tax return filing obligation if they have no other ECI and the correct tax has been withheld on the grant. It is not clear whether the Code for a scholarship or fellowship grant in this case should be Code 15 or Code 50 for Other Income.
This same confusion about the proper Income Code (15 or 50) applies to treaty claims for fellowship grants under two Competent Authority Agreements, one with Austria and one with Belgium. Under these agreements certain individuals may be able to claim a treaty benefit for fellowship grants for research under the Other Income Article of the treaty if the conditions of the article are otherwise met. It is not clear whether the Income Code for a fellowship exempt from tax under the Other Income Article should be 15 or 50. Most of the recipients of these grants will be J-1 Research Scholars, and their fellowships, therefore, deemed to be ECI. The agreements do not address how fellowships for these recipients should be recorded on their U.S. tax returns, or whether they have a filing obligation because the treaty exemption is under a FDAPI provision of the treaty.
Types of Services. Compensation for services provided in the United States is ECI (Income Codes 16 through 20) for which a Form 1040NR or 1040NR-EZ tax return is required. The only exception, as mentioned above, is for nonresident aliens whose only ECI is wages not in excess of one personal exemption amount ($3,650 in 2010).
Code 16. Income Code 16 applies to compensation of an independent contractor. Recipients report this income on Form 1040NR, Schedule C if taxable or as treaty-exempt income on Form 1040NR if exempt under an applicable tax treaty. The compensation may be exempt either under an Income from Independent Services Article or the Business Profits Article of an applicable treaty. The elimination of a separate article covering self-employment income began with the implementation in 2005 with the new tax treaty with theUnited Kingdom. The implementation of this change illustrates the confusion encountered by both payers of compensation for independent contractor services and the recipients of such income.
For the first few years, Table 2 of Publication 515 merely footnoted that compensation for independent services was included in the Business Profits Article. Because no treaty article number was included in column 8 of Table 2, Forms 8233 with valid claims for exemption from tax on such compensation were routinely rejected when submitted to the IRS for review as required by the form’s instructions. Some advisors and treatises stated that no exemption from withholding was allowed or, if allowed, had to be claimed on Form W-8BEN rather than Form 8233, even though no change had been made to Form 8233 instructions or the regulations under section 1441 specifying the use of Form 8233 for compensation for personal services of nonresident alien individuals. There was also confusion about the proper Income Code; should it be 16 or 50? The IRS finally settled the matter with publication of the 2009 edition of IRS publication, table 2, which specified article 7 as the Treaty Article Citation (column 8) for Income Code 16 (column 2), Independent Personal Services (column 3) for the following treaties: Belgium, Bulgaria, Canada, Germany, Iceland, Japan, and United Kingdom.
Codes 17, 18 and 19: Income Code 18 applies to compensation for teaching. It also applies to compensation for engaging in research. There is some confusion on this matter because most of the treaties listed in Table 2 do not indicate that Code 18 applies to compensation for engaging in research. In fact, the income tax treaties with all but two countries (Greece and Pakistan) provide for an exemption from tax for engaging in research in the same article as the benefit for teaching.
Code 19 applies to compensation paid for compensation during study or training. Code 18 and 19 could be used for these types of compensation in situations in which the payment is to an independent contractor claiming a benefit under one of the articles with benefits for teaching, engaging in research, studying or training. The treaty language of these articles does not limit the type of compensation (employment or self-employment) covered by the article.
It would avoid confusion if Publication 515 stated clearly that employers and payers should use Codes 18 and 19, not Code 17, for compensation in these categories even if no treaty benefit is claimed. Applying different Income Codes to the same type of income could cause confusion for taxpayers and their return preparers as well. Income Code 17 should be limited to treaty-exempt employment income as defined in Table 2. Ideally, Income Code 18 would be reserved for compensation covered by the Teacher/Researcher articles and Income Code 19 would be reserved for compensation covered by the Student/Trainee articles.
Code 20: Income Code is 20 is only used for performance income of artists and athletes (entertainers and sportsmen), but see the discussion about Recipient Code 09 above. When, if ever, Code 20 should be used in other performance situations such as key-man speeches (which can result in very generous honorarium payments) is not clear. Recipients of performance income must also qualify under the treaty article covering compensation paid to independent contractors (self-employment) or compensation for dependent personal services (employment) depending on their relationship to their payer. (Treaty-exempt wages must be reported on Form 1042-S.) Therefore, how these performers should report their income on Form 1040NR, as self-employment or employment income, is not described by the Income Code.
Most tax treaties include an Artists and Athletes Article limiting treaty benefits for residents of the treaty country whose gross receipts exceed the treaty maximum amount. Most treaties include reimbursed expenses in the gross receipts amount even though they may be excluded from income if paid or reimbursed to an independent contractor under an accountable plan. Forms 1042-S with Income Code 20 may now include Withholding Allowances (box 3) and Net Income (box 4) which will allow nontaxable amounts includable in the gross receipts amount to be reported in Gross Income (box 2) but not subject to withholding or tax on the recipient’s Form 1040NR.