Form 1040NR Non-Resident Alien Filing Requirements:
Challenges for Tax Preparers
TUESDAY, JANUARY 29, 2012, 1:00-2:50 pm Eastern
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U.S. Taxation of Foreign Investors
Non Resident Alien Individuals & Foreign Corporations
By
Richard S. Lehman Esq.
TAX ATTORNEY
www.LehmanTaxLaw.com
4
Richard S. Lehman Esq.
Richard S. Lehman has over 38 years of practicing tax law in the
United States.
Mr. Lehman has had extensive experience with all areas of the
Internal Revenue code that apply to American taxpayers and
nonresident aliens and foreign corporations investing or conducting
business in the United States, as well as U.S. citizens and domestic
corporations investing abroad.
Richard Lehman began his career in tax law with a law degree from
Georgetown University, a Master’s Degree in tax law from New York
University, and two years of clerking for the Honorable William M.
Fay, a Judge on the United States Tax Court in Washington, D.C. He
spent several years as the senior attorney of the Interpretive Division
of the Chief Counsel’s office at the Internal Revenue Service, the
IRS's internal law firm.
Today, Richard works with other lawyers, accountants, business
leaders and individuals who are struggling to find their way through
the complexities of United States Tax Law.
5
Define The Foreign Investor
– Non
Resident
Alien
Individual
A non U.S. citizen individual who is NOT a Resident Alien
NOTE: Resident Alien (Resident for U.S. Income Tax Purposes)
– Foreign
Corporations
A Foreign Corporation is any corporation that is not formed in the
United States or under the laws of the United States or any state.
6
TAXATION PATTERN
U.S. Resident Alien ("Tax Resident") - Subject to Taxation
1. Income Taxation - Worldwide Income
2. Estate Taxation - Worldwide Assets
3. Gift Taxation - Worldwide Assets
7
Non Resident Alien
Individual Investor – Subject to Taxation
1. Income Taxation - United States source income,
limited type of foreign Source income
2. Estate Tax - United States Situs assets only
(includes real estate)
3. Gift Tax - real and tangible personal property with a
United States Situs
4.
**Branch Tax - Corporations only
8
STATUS FOR TAX PURPOSES
A. Non-Resident Alien - Not a “Resident Alien”
B. Resident for Income Tax Purposes
1. Green Card
2. Substantial Presence Test
3. Voluntary Election
Exceptions:
4. The Closer Connection
5. Treaties: Tie Breaker
C. Foreign Corporations
9
Substantial Presence Test
10
TWO TYPES OF FEDERAL INCOME
TAXATION PATTERNS
Foreign Taxpayer
Foreign Investors (both Alien Individuals and Foreign Corporations) pay U.S. tax on
U.S. income in two entirely different ways depending upon whether the income the
Foreign Taxpayer earns is from "passive" sources or whether the income results
from the Foreign Taxpayer's conduct of an “active trade or business” in the U.S.
Source of Income Rules
1. U.S. Source Income
2. Foreign Source Income
3. Deductions
Taxation of Passive (Non Business Income)
1. 30% Flat Tax Rate - Gross Income
2. Withholding Obligations and Contingency
Taxation of Active Trade or Business Income
1.
2.
3.
4.
Graduated Corporate Tax Rates
Graduated Income Tax Rates
Effectively Connected Income
Income Effectively Connected with a U.S. Business
Treaties
11
SEVERAL IMPORTANT EXCEPTIONS
Capital Gains Taxation
Alien Individual = individual tax rates and generally no tax on capital gains
Foreign Corporation = corporate tax rates and generally no tax on capital gains
Estate Taxation
1.
2.
Alien Individual - Residency for Estate Tax Purposes
Non Resident Tax Rates
3.
U.S. Real Property
1.
U.S. companies holding U.S.Real Property and the U.S. Estate and Gift taxes
The Branch Profits Tax (Foreign Corporation Only)
Foreign Corporation
1.
2.
U.S. Trade or Business
Foreign Source Income
12
Unlike a Foreign Taxpayer that is
taxed on passive U.S. source
income only…
Income of a Foreign Taxpayer that conducts a trade or business
in the U.S. will pay tax on all of its United States source income
and in limited circumstances, U.S. tax must be paid on income
that is earned from foreign sources and not U.S. sources.
Foreign source income that is attributable to a Foreign
Taxpayer's U.S. trade or business activity may be taxed by
the U.S. and is called "Effectively Connected Income".
13
Source of Income Rules
a. U.S. Source Income
b. Foreign Source Income
c. Deductions
There are a strict set of rules that govern the determination
of whether income finds its source in the United States or a
foreign place for U.S. tax purposes.
14
Source of Income
1. Compensation for personal services. The source of income from the
personal services is located at the place where the services are performed.
2. Rents and Royalties: Rent or royalty income has its source at the location,
or place of use, of the leased or licensed property.
3. Real Properly Income and Gain: Income and gain from the rental or sale of
real estate has its source at the place where the property is situated.
4. Sale of Personal Property: Historically, gain from the sale of personal
property has been sourced at the “place of sale” which is generally held to
be the place where title to the goods passes; however, the rules have
become more complex taking other factors in place.
15
Source of Income
5. Interest. The source of interest income is generally determined by
reference to the residence of the debtor; interest paid by a resident of
the United States constitutes U.S. source income, while interest paid
by foreign residents is generally foreign-source income.
6.
6. Dividends. The source of dividend income generally depends on the
nationality or place of incorporation of the corporate payer; that is,
distributions by U.S. corporations constitute domestic-source income,
while dividends of foreign corporations are foreign-source income.
There are, however, several important exceptions to these rules.
7.
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THE EFFECT OF BILATERAL TREATIES EXTREMELY IMPORTANT BENEFITS
Tax treaties between the U.S. and other countries can operate to;
1. reduce (or even eliminate) the rate of U.S. tax on certain
types of U.S. income derived by Foreign Taxpayers situated
in the treaty-partner country;
2. override various statutory source of income rules
3. exempt certain types of income or activities from taxation,
by one or both treaty-partner countries; and
4. extend credit for taxes levied by one country to situations
where the domestic law would not so provide.
18
United States Taxation of Foreign Investors
Richard S. Lehman, Esq.
6018 S.W. 18th Street, Suite C-1
Boca Raton, FL 33433
Tel: 561-368-1113
Fax: 561-368-1349
Skype: LehmanTaxLaw
www.LehmanTaxLaw.com
19
Form 1040NR Non-Resident Alien Filing
Requirements: Challenges for Tax Preparers
By Carolyn R. Turnbull, CPA, MST
Tax Director, McGladrey LLP
© 2013 McGladrey LLP. All Rights Reserved.
© 2013 McGladrey LLP. All Rights Reserved.
© 2013 McGladrey LLP. All Rights Reserved.
INTRODUCTION
© 2013 McGladrey LLP. All Rights Reserved.
Introduction
 Determine the taxpayer’s U.S. resident or
nonresident alien status at the end of the tax year
 What form to file?
-
Form 1040?
Form 1040NR?
Form 1040NR-EZ?
 When to file?
 Where to file?
 File Form 1040X to amend Form 1040NR or Form
1040NR-EZ
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© 2013 McGladrey LLP. All Rights Reserved.
Introduction – cont.
 Potential penalties
-
Civil penalties
• Failure to file
• Late payment of tax
• Accuracy-related penalties
• Fraud
• Filing erroneous claim for refund or credit
• Frivolous tax submission
• Failure to supply taxpayer identification number
-
Criminal penalties
• Tax evasion
• Will failure to file a return, supply information, or pay any tax due
• Fraud and false statements
• Preparing and filing a fraudulent return
• Identity theft
-
Penalty for failure to disclose a treaty position by filing Form 8833
24
© 2013 McGladrey LLP. All Rights Reserved.
IRS Publications
 Publication 15 (Circular E), Employer’s Tax Guide
 Publication 17, Your Federal Income Tax
 Publication 54, Tax Guide for U.S. Citizens and
Resident Aliens Abroad
 Publication 515, Withholding of Tax on Nonresident
Aliens and Foreign Entities
 Publication 519, U.S. Tax Guide for Aliens
 Publication 597, Information on the United StatesCanada Income Tax Treaty
 Publication 901, U.S. Tax Treaties
25
© 2013 McGladrey LLP. All Rights Reserved.
WHO MUST FILE FORM
1040NR
© 2013 McGladrey LLP. All Rights Reserved.
Who Must File Form 1040NR?
 Any of the following apply:
-
-
Filer is an NRA engaged or considered to be engaged in a
U.S. trade or business during the year;
Filer is an NRA not engaged in a U.S. trade or business
and
• Received income from U.S. sources reportable on
Schedule NEC, and
• Not all U.S. tax owed was withheld.
Filer represents a decedent who would have been
required to file Form 1040NR.
Filer is a fiduciary for an estate or trust required to file
Form 1040NR.
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© 2013 McGladrey LLP. All Rights Reserved.
Who Must File Form 1040NR?
 NRA owes any special taxes (e.g., AMT or recapture of
first-time homebuyer credit)
 NRA receives HSA, Archer MSA, or Medicare
Advantage MSA distributions
 NRA has at least $400 of self-employment earnings and
is a resident of a country with whom U.S. has an
international social security agreement.
 NRA wants to claim a refund of overwithheld or overpaid
tax
 NRA wants to claim the benefit of any deductions or
credits (e.g., deductions against income from real
property that he/she is choosing to treat as ECI)
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© 2013 McGladrey LLP. All Rights Reserved.
Exceptions for Filing Form 1040NR

NRA ‘s only U.S. trade or business was performance of personal
services, and
-
Wages are less than the personal exemption ($3,800 for 2012), and
NRA has no need to file a return –
•
•
•
To claim refund of overwithheld taxes,
Satisfy additional withholding at source, or
Claim full or partial exemption for income under an income tax
treaty.

NRA was a student, teacher, or trainee temporarily present in the
U.S. under an “F”, “J”, “M”, or “Q” visa, and NRA has no income
subject to tax under §871.

NRA is a partner in a U.S. partnership not engaged in a U.S. trade or
business during the year and NRA’s Schedule K-1 (Form 1065) includes
only income from U.S. sources reported on Schedule NEC
-
NRA must file Form 1040NR if U.S. taxes are over or under withheld.
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© 2013 McGladrey LLP. All Rights Reserved.
Other Forms NRA May Have to File
 Form 8833, Treaty-Based Return Position
Disclosure Under Section 6114 or 7701(b)
 Form 8840, Closer Connection Exception
Statement for Aliens
 Form 8843, Statement for Exempt Individuals and
Individuals With a Medical Condition
 Form 8938, Statement of Specified Foreign
Financial Assets
 Form 8854, Initial and Annual Expatriation
Statement
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© 2013 McGladrey LLP. All Rights Reserved.
NONRESIDENT ALIEN
© 2013 McGladrey LLP. All Rights Reserved.
Days of Presence in the United States
 General Rule
-
Days of presence includes any day the alien is physically
present in the U.S. at any time during the day.
 Exceptions
-
Regular commuters from Canada or Mexico
-
Days the alien was an exempt individual
Days in transit between U.S. and foreign destination
Crewe members of a foreign vessel
Days that forced the alien to remain in the U.S. because of a
medical condition that developed with the alien was in the
U.S.
•
File Form 8843.
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© 2013 McGladrey LLP. All Rights Reserved.
Exempt Individuals
 Foreign government-related individual temporarily
present in the U.S. under an “A” or “G” visa
 Teacher or trainee temporarily present in the U.S.
under a “J” or “Q” visa who substantially complies
with the terms of the visa
 Student temporarily present in the U.S. under an
“F”, “J”, “M”, or “Q” visa who substantially complies
with the terms of the visa
 Professional athlete temporarily present in the U.S.
to compete in a charitable sports event
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© 2013 McGladrey LLP. All Rights Reserved.
Closer Connection to a Foreign Country
General Rule

Alien who meets the substantial presence test can be treated as an NRA
if the individual:
-
Is present in the U.S. < 183 days during the tax year;
Maintains a tax home in a foreign country during the tax year; and
Has a closer connection during the tax year to one foreign country in
which the individual has a tax home than to the U.S.
•
Exception: Individual has a closer connection to two (but not
more than two) foreign countries.

File Form 8840.

Certain foreign students can use closer connection exception even if
present in the U.S. ≥ 183 days during the tax year.
-
Foreign student files Form 8843 to claim closer connection exception.
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© 2013 McGladrey LLP. All Rights Reserved.
Slide Intentionally Left Blank
Establishing a Closer Connection to a Foreign
Country

Individual has closer connection to foreign country if individual or
Commissioner establishes that the individual has maintained more
significant contacts with the foreign country than the U.S.

Fact and circumstances to be considered:
-
Country individual designates as his/her residence on forms and documents
-
Location of individual’s permanent home
-
Where the individual holds a driver’s license
Types of official documents the individual files (e.g., Form W-9, Form W-8BEN, or
Form W-8ECI)
Location of individual’s family
Location of personal belongings
Individual’s current social, political, cultural, professional, or religious affiliations
Individual’s business activities (other than those that constitute the individual’s tax
home)
Where the individual is registered to vote
Charitable organization to which the individual contributes
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© 2013 McGladrey LLP. All Rights Reserved.
Establishing a Closer Connection to a Foreign
Country – cont.
 Closer connection is unavailable if:
- Individual has personally applied or taken steps during the year to
change his/her status to U.S. permanent resident; or
-
Individual has an application pending during the year for adjustment of
status.
37
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DUAL-RESIDENT TAXPAYERS
© 2013 McGladrey LLP. All Rights Reserved.
Dual-Resident Taxpayers and Coordination
with Income Tax Treaties
 Dual-resident taxpayer is a person who is a resident of the
U.S. and another country under the laws of each country.
 Dual-resident claiming treaty benefits files Form 1040NR or
Form 1040NR-EZ as an NRA.
-
Income tax treaty must contain tie-breaker rules
 Taxpayer must file Form 8833 if he/she determines residency
under an income tax treaty and receives income or payments
> $100,000.
 Dual-resident may be required to file Form 8938.
39
© 2013 McGladrey LLP. All Rights Reserved.
DUAL-STATUS TAXPAYERS
© 2013 McGladrey LLP. All Rights Reserved.
Dual-Status Taxpayers
 Taxpayer is dual-status taxpayer if taxpayer is both an NRA and a
resident alien during the same year.
-
Most common in the year the taxpayer arrives in or departs from the
U.S.
 U.S. tax return filing requirements
-
Dual-status taxpayer separates income between income while a
U.S. resident and income while an NRA.
•
Files Form 1040 with Form 1040NR statement if a resident
alien on last day of the tax year.
•
Files Form 1040NR with Form 1040 statement if an NRA on
last day of the tax year.
-
Dual-status taxpayer is subject to U.S. tax on worldwide income
while a U.S. resident alien.
-
Dual-status taxpayer is subject to U.S. tax on U.S.-source or U.S.
ECI received during part of the year while an NRA.
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© 2013 McGladrey LLP. All Rights Reserved.
Special Rules for Dual-Status Taxpayers
 May not claim the standard deduction, even for the part of the
year the individual is a U.S. resident.
 May not claim Head of Household or use Schedule D of the
Tax Computation Worksheet.
 May not file a joint return unless individual elects to be taxed
as a resident alien rather than a dual-status taxpayer.
 Tax rates
-
Dual-status taxpayer who is married at the end of the year and does
not elect to file a joint return must use married filing separate rates.
-
May be able to use single rates if:
•
Taxpayer lived apart from his/her spouse during the last 6
months of the tax year, and
•
Taxpayer is a married resident of Canada, Mexico, or South
Korea, or a married U.S. national.
42
© 2013 McGladrey LLP. All Rights Reserved.
Special Rules for Dual-Status Taxpayers –
cont.
Exemptions
 May claim personal exemption for him- or herself.
 May only claim personal exemptions for spouse and
dependents for part of the year taxpayer is a U.S.
resident.
 Special rules apply for part of the year a dual-status
taxpayer is a nonresident if taxpayer is:
-
A resident of Canada, Mexico, or South Korea;
A U.S. national; or
A student or business apprentice from India.
43
© 2013 McGladrey LLP. All Rights Reserved.
Special Rules for Dual-Status Taxpayers –
cont.
Tax Credits
 Dual-status taxpayer may not claim the following tax credits:
-
Earned income tax credit;
Credit for elderly or disabled; or
Education tax credits.
44
© 2013 McGladrey LLP. All Rights Reserved.
First Year of Residency for Dual-Status
Taxpayers
 If an individual is a U.S. resident alien during the current
calendar year but was not a U.S. resident alien at any time
during the preceding calendar year, the individual is a U.S.
resident for only the part of the year that begins on the
residency starting date.
-
The individual is a nonresident alien for the part of the year
before that date.
45
© 2013 McGladrey LLP. All Rights Reserved.
First Year of Residency for Dual-Status
Taxpayers
Residency Starting Date for Substantial Presence Test
 General rule: Residency starting date is first day individual is
present in the U.S. during the calendar year.
 Up to 10 days of actual presence in U.S. may be disregarded.
-
Individuals must have closer connection to and tax home in
same foreign country on those days.
-
Individual who is a U.S. resident because of the substantial
presence test and who qualifies to use an early termination date
may exclude up to 10 days of physical presence in the U.S. in
determining the individual’s residency termination.
-
Days are included in calculating the substantial presence test.
Must file statement with the IRS to apply 10-day exclusion.
46
© 2013 McGladrey LLP. All Rights Reserved.
First Year of Residency for Dual-Status
Taxpayers
Residency Starting Date for Green Card Test
 If individual meets green card test but not substantial
presence test during the calendar year, residency starting date
is first day individual is present in the U.S. as lawful
permanent resident.
 If individual meets both green card test and substantial
presence test during the calendar year, residency starting date
is earlier of first day during the calendar year the individual is
present in the U.S. under the substantial presence test or as a
lawful permanent resident.
47
© 2013 McGladrey LLP. All Rights Reserved.
First Year of Residency for Dual-Status
Taxpayers
Residency During Preceding Year (“No Lapse” Rule)
 An individual who was a U.S. resident during any part of the
preceding calendar year and who is a U.S. resident for any
part of the current year will be considered a U.S. resident at
the beginning of the current year.
- Rule applies regardless of whether an individual is a U.S. resident under
the substantial presence test or green card test.
48
© 2013 McGladrey LLP. All Rights Reserved.
First-Year Election (§7701(b)(4)
 An individual who does not meet the either the green card or
the substantial presence test for either the current calendar
year (2012) (the “election year”) or the immediately preceding
calendar year (2011), but who meets the substantial presence
test for the following calendar year (2013), may elect to be
treated as a resident of the U.S. for part of the current
calendar year (2012) if the individual satisfies both of the
following conditions:
- Individual was present in the U.S. ≥ 31 days during the election year;
and
-
Individual was present in the U.S. ≥ 75% of number of days beginning
with first day of the 31-day period and ending last day of election year.
•
Individual may treat up to 5 days of absence from the U.S. as days
of presence in the U.S. for purposes of this 75% requirement
•
Certain days may not be counted for purposes of the 31 days and
75% requirements, above.
49
© 2013 McGladrey LLP. All Rights Reserved.
First-Year Election (§7701(b)(4)
Residency Starting Date
 Residency starting date during the election year is the first day
of the earliest 31-day period that the individual uses to qualify
under 31-day test, above.
 If individual is present in the U.S. for more than one 31-day
period and the individual satisfies the 75% requirement,
above, for each one of those periods, the individual’s
residency starting period is the first day of the first 31-day
period.
 If an individual is present in the U.S. for more than one 31-day
period, but the individual satisfies the 75% requirement for only a
later 31-day period, the individual’s residency starting date is the first
day of the later 31-day period.
50
© 2013 McGladrey LLP. All Rights Reserved.
First-Year Election (§7701(b)(4)
Procedures for Making First-Year Election
 See Appendix
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© 2013 McGladrey LLP. All Rights Reserved.
Slide Intentionally Left Blank
Last Year of Residency for Dual-Status
Taxpayers
 U.S. resident who is not a U.S. resident during any part of the
following year ceases to be a U.S. resident on the residency
termination date.
 “No lapse” rule
- Individual will be treated as a U.S. resident for the entire calendar year if
the individual is a resident during any part of the following calendar year.
53
© 2013 McGladrey LLP. All Rights Reserved.
Last Year of Residency for Dual-Status
Taxpayers
Early Residency Termination Date
 Individual may qualify for earlier residency termination date
than December 31 under following circumstances:
- May use last day individual was physically present in the U.S. if
individual met substantial presence test.
-
May use first day no longer a lawful permanent resident of U.S. if
individual met the green card test.
-
May use later of two dates, above, if individual met both the substantial
presence and green card tests.
 Individual qualifies to use an early residency termination date
if the individual had a tax home in a foreign country and a
closer connection to that foreign country for the remainder of
the last year of the individual’s U.S. residency.
54
© 2013 McGladrey LLP. All Rights Reserved.
Last Year of Residency for Dual-Status
Taxpayers – cont.
De Minimis Presence for Early Residency Termination Date
 Individual who is a U.S. resident because of the substantial
presence test and who qualifies to use an early termination date
may exclude up to 10 days of physical presence in the U.S. in
determining the individual’s residency termination date.
 Individual can exclude days from more than one period, but total
number of days in all periods may not exceed 10 days.
 Individual cannot exclude any days in a period of consecutive
days unless the individual can exclude all of the days in the
period.
 Individual must include any days the individual excludes in
determining the residency termination date in determining
whether the individual meets the substantial presence test.
 Individual must file a statement with the IRS to establish his/her
U.S. residency termination date.
55
© 2013 McGladrey LLP. All Rights Reserved.
Election to Treat Nonresident Spouse as U.S.
Resident (§6013(g))
 Qualifications for §6013(g) election
- Taxpayers are married at the end of the tax year.
- One of the spouses is a U.S. citizen or U.S. resident at the end of the tax
year.
 Consequence of §6013(g) election
-
Both spouses are treated as U.S. residents for entire year of election
and all subsequent years unless the election is suspended or
terminated.
-
Both spouses are taxed on worldwide income.
-
Neither spouse may make a §6013(g) election for any later year,
even if they separate, divorce, or remarry.
Neither spouse can claim they are not U.S. residents under a tax treaty.
Spouses must file a joint return for the year of the election.
 See Appendix for procedures for making a §6013(g) election.
-
Election can be made on an amended return.
56
© 2013 McGladrey LLP. All Rights Reserved.
Election to Treat Nonresident Spouse as U.S.
Resident (§6013(g)) – cont.
Suspension of §6013(g) Election
 Election is suspended for taxable year if neither spouse is a
U.S. spouse (e.g., both spouses are NRAs) during the year.
- Effect is that neither spouse may file a joint return during the
suspension.
 Death of a spouse
- If either spouse dies during any taxable year for which an election under
§6013(g) is in effect, other than the first taxable year for which the election is
to be in effect, the taxable year shall include, solely for purposes of
determining whether an election is in effect only those days during the
taxable year during which both spouses are alive.
•
•
•
If U.S. spouse dies, election is not suspended for that taxable year.
If NRA spouse dies, election is not suspended for that taxable year.
If neither spouse was a U.S. citizen or resident during the period of the
taxable year when both spouses were alive, the election is suspended for that
year even if the surviving spouse subsequently acquires U.S. citizenship or
residency
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Election to Treat Nonresident Spouse as U.S.
Resident (§6013(g)) – cont.
Termination of §6013(g) Election
 Sec. 6013(g) election terminates upon earliest of the
following events:
-
Either spouse revokes the election;
-
Termination of the election by the IRS.
The death of either spouse;
Spouses legally separate under a decree of divorce or
separate maintenance; or
 See Appendix for effective date of termination.
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Electing U.S. Resident Alien Status (§6013(h))
 Dual-status taxpayer can elect to be treated as U.S.
resident alien for entire taxable year if all of the following
are met:
-
Individual is an NRA at the beginning of the year;
-
Individual is married to a U.S. citizen or U.S. resident at the end
of the year; and
-
Spouse joins the taxpayer in making the election.
Individual is a resident alien or U.S. citizen at the year of the
year;
 Spouses who were both NRAs at the beginning of the year
and U.S. residents at the end of the year may make the
election.
 Individual who is single at the end of the year may not
make the election.
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Electing U.S. Resident Alien Status (§6013(h))
 Effect of §6013(h) Election
-
Taxpayer and spouse are both treated as U.S. residents for the
entire tax year.
•
Note: Sec. 6013(h) has no effect on the couple’s U.S. status
in any year subsequent to the year of the election.
-
Both spouses are taxed on their worldwide income.
-
Special instructions and restrictions for dual-status taxpayers do
not apply to the taxpayer.
Spouses must file a joint return for the year of the election.
Neither spouse may make the election for any later year, even if
they separate, divorce, or remarry.
 See Appendix for procedures for making a §6013(h) election.
-
Election can be made on an amended return.
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COMPLETING THE FORM
1040NR
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Overall Structure of Form 1040NR
 Form 1040NR is designed for NRA to report ECI and FDAP
on which insufficient tax was withheld.
-
ECI is reported on pages 1 and 2.
-
FDAP taxable under §871(a)(1) and U.S. source capital gains taxable under
§871(a)(2), and the tax calculated thereon, are reported on Schedule NEC on
page 4. The tax is then carried to line 52 on page 2
 Itemized deductions are reported on Schedule A and carried
to line 37 on page 2 of Form 1040NR.
 Tax on ECI, net of itemized deductions, is computed on page 2 of
Form 1040NR.
 Credits against tax, including credits for taxes withheld at source
and estimated taxes, are shown on page 2.
 Any net tax due or tax overpayment is shown at the bottom of
page 2.
 Page 5 asks a number of questions.
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Community Income

Community income is treated in accordance with the applicable
community property laws with the following exceptions:
-
For earned income other than income from a trade or business
or partnership distributive share income, the income is reported
by the spouse whose services earned the income on his/her
separate return
-
For trade or business income other than partnership distributive
share income, income is reported by the spouse carrying on the
trade or business on that spouse’s return.
-
For partnership distributive share income (loss) , income or loss
is reported on the return of the spouse who is the partner.
-
For income derived from the separate property of one spouse
that is not earned income, trade or business income, or
partnership distributive share income, the income is reported on
the return of the spouse with the separate property.
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Tax Year
 Alien’s tax year is the calendar year unless the alien has
previously established a fiscal year.
 Alien’s fiscal year must end on the last day of a month.
 Alien who has established a fiscal year in a foreign country
prior to becoming subject to U.S. income tax may adopt the
calendar year as his/her taxable year for U.S. tax purposes
without requesting a change in accounting period.
 If an alien who has previously established a fiscal year
becomes a U.S. resident during a calendar year, the alien will
be considered a U.S. resident during any part of the alien’s
fiscal year that falls within that calendar year.
 See Reg. §301.7701(b)-6(b) for examples.
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Identifying Number
 Alien is required to enter either SSN or ITIN on
page 1 of Form 1040NR.
 Fiduciary enters estate or trust’s EIN on page 1 of
Form 1040NR.
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Filing Status
 Married NRAs are generally taxed at the married filing
separate tax rates.
-
Special rules exist for residents of Canada, Mexico. South
Korea, or married U.S. nationals.
 Taxpayer who is married at the end of the year is
considered married for the entire tax year.
 Taxpayer who is single, divorced, or legally separated is
considered single for the entire tax year.
 If the taxpayer’s spouse died during the tax year, the
taxpayer is considered married to that spouse for the
entire tax year unless the spouse remarried before the
end of the tax year.
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Filing Status – cont.
 Married taxpayer who lives apart from his/her spouse, and
who is a resident of Canada, Mexico, or South Korea, or is a
U.S. national, may file as single if they meet the following
requirements:
-
Taxpayer files a return separate from his/her spouse;
-
Taxpayer lived apart from his/her spouse during the last 6
months of the year;
-
Taxpayer’s home was the main home for a child, stepchild, or
foster child for more than half of the year; and
-
Taxpayer can claim a dependency exemption for the child, or the
child’s other parent claims the dependency exemption under the
rules for children of divorced or separated par Canada, Mexico.
South Korea, or married U.S. nationals.
Taxpayer paid more than half the cost to maintain his/her home
during the year;
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Filing Status – cont.
 Married residents of Canada or Mexico or married
U.S. nationals who meet the five requirements
should check box 1 on page 1 of Form 1040NR.
 Married residents of South Korea who meet the five
requirements should check box 2 on page 1 of
Form 1040NR.
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Filing Status – cont.
 Qualifying widow(er) with qualifying child
-
Taxpayer may check box 4 on page 1 if he/she meets all of the
following requirements:
•
Taxpayer was a resident of Canada, Mexico, South Korea, or a
U.S. national;
•
Taxpayer had not remarried by the end of the current tax year
and taxpayer’s spouse died in one of the two preceding years;
•
Taxpayer has a child or stepchild (not including a foster child)
whom taxpayer can claim as a dependent;
•
•
•
•
Child lived in the taxpayer’s home for the entire year;
Taxpayer paid > one-half cost of maintaining the home;
Taxpayer was U.S. citizen or resident in year spouse died; and
Taxpayer could have filed a joint return in year spouse died,
even if taxpayer did not do so.
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Exemptions
 NRA may generally claim personal exemption for him- or herself.
 Residents of India who were students or business apprentices
may be able to claim exemptions for their spouse and
dependents.
 Married residents of Canada, Mexico, or South Korea, or married
U.S. nationals may claim an exemption for their spouse only if
spouse had no gross income and cannot be claimed as a
dependent on another U.S. taxpayer’s return.
 Married resident of South Korea may not claim exemption for
his/her spouse if spouse did not live with taxpayer in the U.S. at
any time during the year.
 Resident of Canada or Mexico or a U.S. national may claim an
exemption for a child or other dependent on the same terms as a
U.S. citizen.
 Resident of South Korea may only claim an exemption for child
who lived with taxpayer in the U.S. at some time during the year.
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Income Effectively Connected With a U.S.
Trade or Business (“ECI”)

ECI, after allowable deductions, is taxed at graduated rates.

Types of ECI
-
Personal services
•
See Appendix for the following exemptions:
-
Certain compensation for services provided in the U.S. for a foreign
employer;
-
Certain compensation for services performed as a regular crew member
of a foreign vessel engaged in transportation between the U.S. and a
foreign country or U.S. possession;
-
Certain compensation received from a foreign employer by nonresident
students or exchange visitors present in the U.S. under an “F”, “J”, “M”,
or “Q” visa;
-
Certain income received under a qualified trust or from a qualified trust
exempt from U.S. tax;
•
Taxable scholarship or fellowship grants received by a student or trainee
temporarily present in the U.S. under an “F”, “J”, “M”, or “Q” visa.
•
•
Distributive share of partnership income attributable to U.S. trade or business
Distributions of DNI from an estate or trust engaged in a U.S. trade or
business
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Income Effectively Connected With a U.S.
Trade or Business (“ECI”)
 Types of ECI – cont.
-
A taxpayer who trades in stocks, securities, and commodities may or
may not be engaged in a trade or business.
-
Investment income may or may not be effectively connected with a
U.S. trade or business.
•
•
•
FDAP
Gains (some of which are considered capital gains) from the
sale or exchange of:
-
Timber, coal, or domestic iron ore with a retained economic
interest;
-
Patents, copyrights, and similar property on which taxpayer
receives contingent payments after October 4, 1966;
-
Patents transferred before October 5, 1966; and
OID obligations.
Capital gains (and losses)
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Income Effectively Connected With a U.S.
Trade or Business (“ECI”)
 Tests to determine ECI
-
Asset-use test
Business activities test
 Transportation income
 Special rules exist for interests in U.S. real property
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Slide Intentionally Left Blank
Itemized Deductions – Schedule A
 NRAs may generally not claim the standard deduction.
-
Exception: Students and business apprentices who are eligible for the
benefits of Article 21(2) of the U.S.-India Income Tax Treaty can claim the
standard deduction if they do not itemize.
 Most deductions are allowed only to the extent they are allocated
and apportioned to ECI, including:
-
State and local income taxes;
-
Other miscellaneous deductions, such as:
Job expenses and certain other miscellaneous itemized deductions
subject to the 2% of AGI limitation;
•
•
Casualty and theft losses of income-producing property;
•
•
•
Deduction for repayment of amounts under claim of right > $,3,000;
Losses from other activities from Schedule K-1 (Form 1065-B), box
2;
Certain unrecovered investment in a pension; and
Impairment-related work expenses of a disabled person.
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Itemized Deductions – Schedule A – cont.
 Expenses that are allowed even if they do not relate
to ECI
-
Charitable donations
Casualty and theft losses
•
Property must be located in the U.S. at the time of
casualty or theft.
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Tax Liability (Before Credits and Payments)
 Income tax computed on ECI
-
-
Regular tax
Additional taxes, if applicable
•
Form 8814, Parent’s Election to Report Child’s Interest and
Dividends
•
Form 4972, Tax on Lump-Sum Distributions
Alternative minimum tax, Form 6251
 Other taxes
-
Tax on income not effectively connected with a U.S. trade or
business from Schedule NEC
-
Unreported social security and Medicare taxes from Form 4137 and
Form 8919
-
Additional tax on IRAs, other retirement plans, etc.
Transportation tax
Household employment taxes from Schedule H (Form 1040)
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Tax Credits

Credits are only allowed against ECI.

Some of the credits the NRA may be able to claim include:

Foreign tax credit
Credit for child and dependent care expenses
Retirement savings contribution credit
Child tax credit
Mortgage interest credit (Form 8936)
Qualified adoption expenses (Form 8939)
Residential energy credits (Form 5695)
General business credits (Form 3800)
Credit for prior year minimum tax (Form 8801)
NRA may not claim:
-
Earned income tax credit
Credit for the elderly or disabled
Education credits
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Noneffectively Connected Income (NEC)
 Fixed or determinable annual periodic income (“FDAP”)
-
Dividends
-
Certain gross proceeds from gambling winnings in the U.S.
Interest (other than OID)
Rents
Premiums
Annuities
Salaries
Wages
Other compensation
Royalties
OID from the sale, exchange, or payment on a bond or other debt
instrument issued at a discount after March 31, 1972
Eighty-five percent of U.S. social security and tier 1 railroad retirement
benefits, unless exempted by treaty
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Noneffectively Connected Income (NEC) –
cont.
 Capital gains and losses from the sale of property
not effectively connected with a U.S. trade or
business
-
Note: Gains and losses from the sale of a U.S. real
property interest are treated as ECI and should be
reported on Schedule D, Form 4797, or both.
 Taxed at flat 30-percent rate, unless reduced by
treaty or statute.
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NEW IRC §1411, MEDICARE
SURTAX ON NET INVESTMENT
INCOME
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New IRC §1411, Medicare Surtax on Net
Investment Income
Background
 Sec. 1411(a) imposes a 3.8% tax on the lesser of an
individual’s:
-
Net investment income, or
The excess (if any) of –
•
•
Modified adjusted gross income (MAGI) over
A threshold amount.
 Threshold amount
-
$250,000 for taxpayers filing a joint return or surviving
spouses
-
$125,000 for married taxpayers filing separately
$200,000 for other taxpayers
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New IRC §1411, Medicare Surtax on Net
Investment Income – cont.
Background – cont.
 For estates and trusts, §1411(a)(2) imposes a 3.8%
tax on the lesser of:
-
Undistributed net investment income, or
The excess (if any) of –
•
•
Adjusted gross income, over
The dollar amount at which the highest tax bracket in
which §1(e) begins for the year.
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New IRC §1411, Medicare Surtax on Net
Investment Income – cont.
Background – cont.

Sec. 1411(c) defines “net investment income” as the excess (if any) of:
-

•
Gross income from interest, dividends, annuities, royalties, and rents, other
than such income which is derived in the ordinary course of a trade or
business described in §1411(c)(2),
•
Other gross income derived from a trade or business described in
§1411(c)(2), and
•
Net gain (to the extent taken into account in computing taxable income)
attributable to the disposition of property other than property held in a trade or
business not described in §1411(c)(2), over
The deductions allowed by Subtitle A of the Internal Revenue Code that are properly
allocable to such gross income or net gain.
A trade or business is described in §1411(c)(2) if the trade or business is:

The sum of –
A passive activity with respect to the taxpayer, or
A trade or business of trading in financial instruments or commodities.
Sec. 1411(e) provides that §1411 does not apply to a nonresident alien.
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Proposed §1411 Regulations (REG-13050711, December 5, 2012)
 Prop. Reg. §1.1411-2(a)(2)(i) provides that in the
case of a U.S. citizen or resident who is married (as
defined in §7703) to an NRA, the spouses will be
treated as married filing separately for purposes of
§1411.
-
For purposes of calculating the §1411 tax, the citizen or
resident spouse will be subject to the $125,000 threshold
for married filing separately, and the NRA will be exempt
from §1411.
-
Each spouse must separately calculate his/her own net
investment income.
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Proposed §1411 Regulations (REG-13050711, December 5, 2012) – cont.
 Prop. Reg. §1.1411-2(a)(2)(i)(B) provides that
married taxpayers who file a Federal joint income
tax return pursuant to a §6013(g) election can also
elect to be treated as making a §6013(g) election for
purposes of §1411.
-
The effect of such election is to include combined income
of the two spouses in the §1411(a)(1) calculation and
subject the income to the $250,000 threshold for married
taxpayers filing a joint return.
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Proposed §1411 Regulations (REG-13050711, December 5, 2012) – cont.
Residents of U.S. Territories

An individual who is a citizen, resident, or nonresident alien of the U.S.
may qualify as a bona fide resident of a U.S. territory.

Application of §1411 to a bona fide resident of a U.S. territory depends on
whether the territory has a mirror code system of taxation.
-
Bona fide residents of a territory that has a mirror code system have no obligation to
file a U.S. income tax return provided they report and pay tax to their respective
U.S. territory.
-
Result is that §1411 does not apply to bona fide residents of the U.S. territories that
have a mirror code system.
-
Three (out of five) territories that have a mirror code of taxation include:
•
•
•
-
Guam
Northern Mariana Islands
United States Virgin Islands
U.S. territories that do not have a mirror code system are:
•
•
Puerto Rico
American Samoa
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Proposed §1411 Regulations (REG-13050711, December 5, 2012) – cont.
Residents of U.S. Territories
 Tax under §1411(a) is applicable to bona fide residents of
Puerto Rico and American Samoa if they have U.S. reportable
income that gives rise to both net investment income and
MAGI exceeds the reporting threshold.
 Sec. 1411(a) does not apply, however, to bona fide residents
of Puerto Rico and American Samoa if they are U.S.
nonresident aliens.
-
Individuals who are bona fide residents of nonmirror code
jurisdictions remain subject to Chapter 1 of Subtitle A
pursuant to §876.
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Disclaimer
The information contained herein is general in nature and based on
authorities that are subject to change. McGladrey LLP guarantees neither the
accuracy nor completeness of any information and is not responsible for any
errors or omissions, or for results obtained by others as a result of reliance
upon such information. McGladrey LLP assumes no obligation to inform the
reader of any changes in tax laws or other factors that could affect information
contained herein. This publication does not, and is not intended to, provide
legal, tax or accounting advice, and readers should consult their tax advisors
concerning the application of tax laws to their particular situations.
Circular 230 Disclosure
This analysis is not tax advice and is not intended or written to be used, and
cannot be used, for purposes of avoiding tax penalties that may be imposed
on any taxpayer.
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