All resident and nonresident aliens must face a different set of rules when it comes to filing their taxes when compared to the actual citizens of the United States. There are many categories of filers who are not otherwise US citizens and therefore may not be liable to declare certain categories of income and revenue, depending on a case to case basis.

Classification of both resident and non-resident aliens:
Resident Aliens

These are non-U.S. citizens who possess green cards. This means that they have passed the residence test (as per federal law).

Non-resident Aliens

These are those aliens are legally present on United States territory but do not possess a green card. Such a category includes, students, tourists etc. Or any other visitor to the United States who is in possession of a valid visa.

Illegal Aliens

These are those individuals who have managed to sneak into the United States by evading border security and as such do not have a valid United States visa. Such people are outside the scope of all IRS laws since they do not have either Social Security Numbers or Individual Taxpayer Identification Numbers and are therefore outside the tax net altogether. These people have not just entered US territory illegally but their stay there is also entirely in contravention of state, local and federal laws. If apprehended, they are sent to deportation centers and subsequently deported to their country of origin. This is why they have no tax liabilities whatsoever.

Taxation Requirements for Non-resident Aliens

Such aliens are only required to pay income tax on any income that is earned exclusively through a U.S. source. This is why it is not incumbent on them to pay tax on any income (wages, profits and revenue) earned through other foreign sources.

Let us take the example of a non resident alien from India. If this person owns a business in India and another business in the United States, he would not be taxed on the former but would have to pay taxes only for the latter source of income. In other words, his business in India is of no concern to tax authorities in the United States. For such individuals there are certain relief measures and in this regard the tax authorities allow them to claim their spouses as dependents in certain (often pre-authorized) cases instead of filing a joint return. A smart nonresident alien tax strategy is to keep careful records to show the sources of all of their income so that the Internal Revenue Service is able to clearly pinpoint precisely what should be taxed and what should be exempted from such taxation.

Taxation of Resident Alien Income
Unlike their non-resident counterparts, all resident aliens are taxed on all forms of income that they receive, irrespective of the fact that it is of domestic origin or is stemming from foreign investments. This also includes any and all payments received from government bodies of a foreign country such as pensions and other gratuities. There is a relief measure in place under which a resident alien ‘may’ have the right to claim the ‘foreign earned income exclusion and/or the foreign tax credit’ facility if he or she fulfills all the criteria for pre-qualification of the same.

However, a resident alien who is currently working under the employ of a foreign government in the U.S. may be able to claim an exemption on his or her annul taxable salary only if the United States has a corresponding tax treaty with the foreign government in question.

Marital Status Requirements

In terms of marital status, there are two main categories for a nonresident alien when it comes to filing tax particulars:

  • Single nonresident alien
  • Married nonresident alien

An important rule to remember when married (and) filing jointly is that you are not allowed to do so if either your spouse was a non-resident alien at any point in time, during the year the tax assessment is taking place. However, there is a cravat here and that is that all non-resident aliens that have a spouse who is a US citizen (irrespective of gender) as well as other residents, have been given the choice of being treated as U.S. residents and therefore have the right to file returns jointly.

Head of Household

As per existing US law, it is not permissible to file tax returns as head of household if you are a nonresident alien during the time period in which the tax assessment takes place.

Married Nonresident Aliens Filing Separately

All legally married nonresident aliens, (by legally married, it is meant that the marriage has to be recognized under US law and marriages as per different tribal and social customs may not be accepted as such; kindly consult your lawyer for legal information regarding marriages that are recognized under existing state and federal legislation) but if your partner is neither a US resident nor is he or she an American citizen, then it is incumbent upon you to use either the Tax Table column or the Tax Rate Schedule for married couples filing separate returns when trying to decide applicable tax on all income that is effectively connected with either American business or trade (or both).

It is not permissible for you to use either the Tax Rate Schedule or for that matter the Tax Table column as a lone individual

Standard Deductions

Such deductions are not applicable for non-resident aliens and therefore they cannot make any claims for the same. However, there is a loophole for business apprentices as well as students from India who may (potentially) be eligible to claim such a deduction under Article 21 of the “U.S.A India Income Tax Treaty.”

Deductions

Under US law it is permissible to claim deductions so as to be able to accurately gauge your “effectively connected taxable income”  However, here it is important to understand that it is usually not possible to claim any deductions on any and all incomes that are otherwise not connected to the business activities that you currently conduct in the US. Here only personal exemptions can apply along with certain deductions that are assessed on a case to case basis. Furthermore it is possible to claim deductions only to the amount that is associated with your “effectively connected income.”

Here, you should note that non-resident aliens can only subtract those (case by case) deductions if they in receipt of any and all incomes and profits that have been accrued though a connection with their U.S. business or trade. Some of these deductions also include:

  • All state and local income taxes (wherever applicable)
  • Any form of charitable contributions to U.S.owned non profit organizations
  • Losses that are a result of either theft or any other casualty or unforeseen calamity
  • Miscellaneous deductions (to be decided on an item by item basis)
  • The monthly expenses that are deemed necessary (for tax purposes) for the daily running of an American business or trade.

Claiming itemized deductions (On an item to item basis)

For the purpose of claiming such deductions you should use the IRS’s Schedule A of Form 1040NR to. On the other hand, should you be filing Form 1040NR-EZ, then it is necessary that you should be aware that you can only claim a specific deduction for state or local income taxes (as they exist in that particular state or county). Should you attempt to claim any other type of deduction, it is mandatory for you to file Form 1040NR.

Non Resident Alien Tax Strategies

If any nonresident alien individual earns a profitable income from a source based in the United States but is not ‘personally’ engaged in the trade or business during the period of assessment of his income tax, even while his or her overall tax liability is virtually nil because all such taxable income has been taxed at source, then such a taxpayer is not required to file a tax return for that particular assessment period.  But on the other hand, if the non-resident alien is desirous of obtaining a refund on his or her taxes that have been withheld at source then he or she must file a tax return even if such a return is not required due to the very low income generated though the US source. This also holds true if said alien wants to seek an exemption due to treaty regulations between his country of origin and the US.

Example

Mr. John Smith received $2,000 in income arising from business or trade located in the US. His personal exemption was $3,000 for the tax year ending 2012. In spite of the fact that his actual income is actually markedly less then the personal exemption he has received, it is incumbent on him to file Form 1040NR (or 1040NR-EZ) due to the fact that his income stemmed from involvement in a U.S. trade or business.

Strategy

Since even very small incomes that are generated though U.S business or trade require the filing of tax returns in the U.S, it is possible for the non resident alien to seek to defer U.S connected income so that the same may be recognized in a single assessment period in order to ensure that it would not be spread over a multiple year period.

Personal Exemptions (applicable only on taxable income)

As a general rule, all non resident aliens that are involved in any business or trade (or related activity) in the United States of America are allowed a single personal exemption (to be claimed). Said personal exemption may be for your spouse or any dependent if you fall in any of the categories mentioned below.

If you are a national of:

  • US
  • Canada
  • Mexico

In addition to the above, it is possible to seek such an exemption for any dependant (generally spouse) if the following conditions are met.

  • They do not have any income for U.S. tax purposes and were furthermore not the dependent of another taxpayer
  • The exemptions for any dependents that you have, who may be able to meet the criteria for personal exemptions.

Here it is pertinent to note that all residents’ of Canada, Mexico as well as nationals of the United States of America are subject to the same rules and regulations as other United States citizens as regards the eligibility criteria that defines the status of a dependent with reference to income tax return . That is, when and how such exemptions may be claimed for an individual dependent (as per IRS requirements.)

In this regard, there are several tax related treaties that the US government has signed with certain allied nations such as South Korea as well as India. Pursuant to these treaties individuals belonging toSouth Korea and many business apprentices and students from India may potentially be eligible for certain exemptions for either their spouse or any other (individual) dependents.

However, it is very important to note that for you to be able to claim such exemptions, it is of pivotal importance that your spouse and each dependent must have either n of the following to claim personal exemptions or be declared a dependent:

  • Individual Taxpayer Identification Number  or
  • Social Security Number

Tax implications for non resident aliens

All tax assessments for any foreign investor (irrespective of country of origin) will depend on that individual’s classification as either a non-resident or a resident alien.

In the case of the former, i.e. to be considered a non-resident alien, the individual investor must meet a stringent set of criteria which includes:

  • First of all, the person cannot have had a green card (a permit issued by the United States government that allows individuals to live and work in the United States on a permanent basis) at any time during the relevant period under assessment (The year 2016 for instance)
  • Such individuals cannot have resided in the U.S. for more than 183 days (maximum) in the past 3 year period. (This would also include the current reporting and assessment period as well).
  • Nevertheless all non-U.S. citizens who are in possession of valid green cards (an informal term for a United States Permanent Resident Card) and have been on United States territory for a period exceeding at least 183 days would automatically be categorized as resident aliens, at least for the purpose of assessment of their tax returns and would therefore be subjected to different rules and regulations than their non-resident alien counterparts under existing rules and regulations.

If an investor were to be classified as a ‘non-resident alien’ while his only business and investment activity would be in the trading and holding of non tangible trading assets (such as stocks, mutual funds, commodities and the like) within a United States dollar-denominated brokerage firm or any other agent operating under the same principles, then said investor’s income would automatically fall under the ambit of the following tax guidelines.

Capital gains

In terms of capital gains (capital gain is an increase in the value of a capital asset such as an investment in stocks or commodities that is realized when the asset is sold for a profit) non-resident aliens are subject to no U.S. capital gains tax whatsoever, on the profits he or she may have accrued from this sale. Since such a tax is not applicable to the investor no amount is either deducted or withed at source by either the brokerage firm or the agent acting on behalf of such a firm.

Nevertheless, this would not mean that it is permissible for the non resident alien to continue to trade without being made to pay any taxes whatsoever since such taxes would inevitably be paid in his or her country of origin.

However, dividends (on stock owned by non resident aliens) are subjected to a dividend tax rate of thirty percent on all dividends paid out by joint stock companies incorporated in the United States. . However, such dividends may be beyond the purview of this tax only if said dividends are paid by foreign companies or alternately, if these dividends are short-term capital gain dividends or even interest-related dividends.

Moreover, the thirty percent flat rate may be subject to certain relaxations depending on treaty regulations between the country of origin of the non resident alien and the United States of America.

This is why when you are drafting Non Resident Alien Tax Strategies it is important that you read up o the relevant treaty obligations between your home country and the United States. This holds especially true for residents of India as well as South Korea since these two countries to have such tax related treaties with America.