Paying compensation for services to foreign nationals is difficult because of the complexity of the U.S. tax laws and tax treaty provisions and procedures. The ten rules below provide a framework of information to consider when paying foreign nationals for services.
Rule #1: All compensation for services performed in the U.S. is subject to U.S. taxes unless an exception applies.
Rule #2: How a foreign national who is performing services in the U.S. is taxed depends on his or her U.S. tax status — resident alien or nonresident alien. These are tax terms, not immigration terms.
Rule #3: A nonimmigrant’s U.S. tax residency status depends on his or her U.S. immigration status and U.S. presence over a three-calendar year period. A nonimmigrant is a resident alien if he or she has been physically present in the U.S. for 183 days or more, for any reason, based on a formula unless an exception applies. U.S. days include partial days.
Rule #4: An immigrant (also called a green-card holder), like a U.S. citizen, is subject to U.S. tax on worldwide income, even if the individual resides and works abroad, unless an exception applies.
Rule #5: A resident alien is subject to U.S. tax on worldwide income regardless of the currency or location of payment. A nonresident alien is subject to U.S. tax on U.S. source income and income effectively connected to the conduct of a U.S. trade or business (called ECI). Compensation for services performed in the U.S. is ECI regardless of the currency or location of payment unless an exception applies.
Rule #6: The U.S., like foreign governments, collects taxes on the income of its nonresidents through withholding taxes. The U.S. withholding tax is 30 percent unless an exception applies. One exception is wages subject to wage withholding.
Rule #7: An employer is required to withhold federal and state income taxes, and Social Security and Medicare taxes, on compensation paid for employment services performed in the U.S. unless an exception applies. This rule applies to both U.S. and foreign employers.
Rule #8: All payments made by an employer to or on behalf of an employee, including cash and the fair market value of benefits-in-kind, are wages subject to payroll taxes unless an exception applies. One exception from wage-withholding is an exemption from withholding under a provision of an applicable income tax treaty.
Rule #9: In addition to meeting the conditions for an exception, an individual must document the exception usually by submitting a completed form, signed under the penalties of perjury, to the employer or payer; otherwise, the exception does not apply.
Rule #10: The IRS enforces withholding by collecting the tax, plus penalties and interest, from the payer who fails to withhold or to collect the necessary form for the exemption from withholding. Additional penalties are imposed for the failure to report the income.