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US Taxation of Non-residents

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US Taxation of Non-residents

Postby Pinskylaw.ca » 17 Dec 2016, 12:04

The US taxes a non-resident on income that is "effectively connected" with conduct of a US trade or business at the same graduated rates that apply to US citizens and residents. Deductions against this income are allowed to the extent that they relate to income that effectively connected with the conduct of the trade or business. The US also taxes a non-resident on US source "fixed or determinable periodic income" (FDAPI) at a rate of 30% (provided the income is not effectively connected with the conduct of a US trade or business). These domestic tax rules may be modified (and reduced) by the Treaty. This is usually accomplished by the non-resident completing US Form W-8ECI (Certificate of Foreign Person's Claim That Income is Effectively Connected with a US Trade or Business) or Form W-8BEN (Certificate of Foreign Status of Beneficial Owner) and submitting not to the Internal Revenue Service (IRS) but to the potential tax withholding agent. The US taxation of various US source income that may be earned by a Snowbird is considered below.

Business Profits

The US taxes a non-resident on income that is effectively connected with the conduct of a US trade or business at the same graduated rates that apply to US citizens and residents. Married individuals, however, who are non-residents, will have a different, less advantageous filing status - married filing separately. The Treaty provides an exemption from US taxation of US source business profits earned by a non-resident where the business is not carried on through a permanent establishment in the US. It should be noted that trading in stocks, securities and commodities on one's own account through a US resident broker or agent does not generally constitute a trade or business within the US.

Income derived from the provision of independent personal services in the US is taxable in the US in the same way as business profits or income attributable to a permanent establishment in the US. The Treaty provides that income from independent personal services will only be subject to US taxation provided that the non-resident has a permanent establishment or fixed base in the United States regularly available to him or her. It should be noted that independent personal services are subject to withholding at source in the US. A non-resident entitled to relief under the Treaty may complete Form 8233 (Exemption from Withholding on Compensation for Independent Personal Services of a Non-resident Alien Individual) to obtain an exemption from this withholding requirement. The form 8233 should not be sent to the IRS but rather to the potential US withholding agent.

Salary and Wages

A non-resident who performs services in the US is considered to be engaged in a US trade or business. Accordingly, under the Code, he or she is taxed on income earned for the performance of those services at the same graduated rates applicable to US citizens and residents. Exceptions exist for services performed by a non-resident for foreign persons, organizations or offices, provided their remuneration for these services is not more than US$3,000 and the non-resident is not present in the US for more than 90 days. The Treaty provides an exemption from US taxation of US source salary and wages earned by a non-resident if the remuneration does not exceed US$10,000. In addition, the Treaty provides an exemption from US taxation US salary and wages earned by non-resident if the non-resident is present in the US for fewer than 183 days in the calendar year and the remuneration earned by the non-resident is not borne by a US resident employer (or a permanent establishment or a fixed base that the employer has in the US or charged back to a US resident employer.

Rental Income from US Real Property

A Snowbird may rent out his or her US house or apartment. Rental income derived from US real estate is generally not considered to be effectively connected with the conduct of a US trade or business. Consequently, such rental income will be subject to 30% tax on the gross amount of the rental income. The Treaty does not provide relief from this 30% tax. A non-resident alien may, however, escape this 30% tax by electing to treat rental income from US real estate as income which is effectively connected with the conduct of a trade or business in the US. As a consequence of this election, the rental income, net of expenses, will be taxed in the US at applicable marginal rates. The election will apply to all US rental income earned by the non-resident. The election remains in effect for subsequent taxation years unless approval by the Secretary to revoke is received. This election is made by attaching a statement to the US tax return filed by the non-resident.

Sale of US Real Estate

A gain or loss realized by a non-resident on the disposition of US real estate is considered to be effectively connected with a trade or business in the US. Consequently, any gain will be subject to the US graduated tax rates. The lower long term capital gains rates (currently 0%, 15%, and 20%) available to individuals are not available to corporations if, for example, US real estate is held indirectly through a corporation for e.g. US estate tax reasons. This distinction is very important for Snowbird holding US real estate. Generally, the transferee (buyer) of the US real estate will be required to withhold 10% of the purchase price. There are exceptions, one of which exists if the purchase price does not exceed US$300,000 and the buyer intends to use the property as a personal residence. If the tax on gain is substantially less the 10% withholding tax, the Snowbird should apply with the IRS for reduced withholding. This is done by the filing of the Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of US Real Property Interests, with the IRS prior to the closing of the real estate transaction.
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