FAQ: Paying wages to foreign nationals

When can they be treated like U.S. citizens for income tax purposes?

The number of foreign nationals in today’s workforce has increased tremendously in recent years.

Businesses – especially those in high technology and specialized fields – find they have such a need for foreign workers that they willingly take on complex immigration projects to obtain work authorization, only to follow with the conundrum of how to handle payroll reporting and withholdings.

One of the most frequently asked questions from employers is whether foreign nationals can be treated like U.S. citizens for income tax withholding and reporting purposes. The answer requires a determination of whether the individual is considered a nonresident alien for tax purposes.

A foreign national is generally considered a “nonresident alien” for U.S. income tax purposes, unless he or she satisfies one of two tests: the “substantial presence test” or the “green card test.”

The substantial presence test counts the total number of days an individual has been present in the United States during a period of three calendar years, according to a specific formula. If, in accordance with the formula, a total of 183 days or more is calculated, then the individual is a resident alien for tax purposes. If the total is less than 183 days, the individual is considered a nonresident alien.

Using the green card test, a foreign national is a resident alien if he or she was a lawful permanent resident of the U.S. (also known as a green card holder) at any time during a calendar year.

If, in accordance with the substantial presence test or the green card test, a foreign national is determined to be a resident alien for U.S. income tax purposes, then he or she is taxed in the same manner as a U.S. citizen, and the employer’s payroll withholding and reporting requirements are also the same.

If an individual is determined to be a nonresident alien, then special considerations apply, some of which are discussed below.

Regarding income tax withholdings from payroll:

• Social Security and Medicare – An employer generally must withhold Social Security and Medicare tax (FICA). However, there are certain exemptions for nonresident alien students, teachers, researchers, trainees and some other nonresident aliens (generally, F-1, J-1, M-1 and Q-1 nonimmigrants).

For a certain time period, these individuals are not subject to Social Security and Medicare taxes on their pay. Social Security and Medicare taxes should not be withheld or paid for these individuals for the required period.

Other nonimmigrants, such as employees working pursuant to H-1, E3 and TN visas, are not exempt from FICA. Social Security and Medicare must be withheld from these individuals’ payroll and paid quarterly by the employer.

• Tax treaties – The U.S. has entered into bilateral income tax treaties with many foreign countries. One of the purposes of the treaties is to avoid double taxation of income that may arise as a result of the United States' and another country's attempts to tax the same income.

Under these treaties, residents (not necessarily citizens) of foreign countries are taxed at a reduced rate or are exempt from U.S. income taxes on certain types of income they receive from sources within the U.S. These reduced rates and exemptions vary among countries and specific types of income.

The IRS maintains a list of these treaties, which must be consulted in each specific case at its website.

• Workers outside the U.S. – Payments made to a foreign national who performs services outside of the U.S. are not subject to payroll taxes, nor are there any U.S. reporting obligations.

Taxation in general is complex. Taxation of foreign nationals is a topic that sparks trepidation in many immigration and tax professionals. Although this article outlines some common payroll issues, professionals who specialize in immigration issues and taxation of foreign nationals should be consulted for each individual situation, thus avoiding costly negative consequences.

Shiva Karimi, an attorney in the immigration practice of the McLane Law Firm, can be reached at 781-904-2690.