What’s the Difference Between a Resident and Non-Resident Alien?

As it relates to individuals, the United States taxing jurisdiction applies to U.S. citizens, resident aliens and non-resident aliens. (The term alien is used to describe anyone who is not a U.S. citizen.)

U.S. citizens are subject to U.S. income tax on their income from all sources, domestic or foreign. If they have foreign source income taxed by the source country, they can seek relief from double taxation by way of the foreign tax credit, if allowed, under U.S. law or from an applicable bilateral tax treaty with the source country.

Resident aliens are subject to U.S. income tax to the same extent as U.S. citizens. Non-resident aliens can be subject to U.S. taxation to a certain extent on their income from sources within the United States.

In short, certain income from U.S. sources is subject to U.S. taxation regardless of who receives it. But how do you know your alien status?

What is a resident alien?

Resident aliens are non-U.S. citizens who are taxable as if they were citizens. You will be treated as a resident alien if you are foreign-born and either have a green card or meet the test for substantial presence in the U.S.

You satisfy the substantial presence test if you have been in the U.S. for:

• More than 31 days during the current year, and

• At least 183 days during a three-year period, including the current year.

A non-resident alien is a person who is not a U.S. citizen and does not satisfy either the green card or substantial presence test for resident alien status. However, you may still be treated as a resident alien if you’re married to a resident alien or U.S. citizen and filing a joint return.

Important IRS Tax Rules for Green Card Holders

Few new green card holders understand the tax implications that come with their new resident status. Immigration attorneys often don’t have the resources or know-how to advise new green card holders of their tax status—leaving it up to residents to figure it out on their own.

What are the tax implications for resident aliens?

If you’re treated as a resident alien, you’ll be taxable on income from all sources. This includes both foreign and domestic income — the same as a U.S. citizen. If you’re also taxable in your country of citizenship, you can file for a foreign tax credit under U.S. law. Alternatively, you might qualify for the avoidance of double taxation under a U.S. bilateral tax treaty with your citizenship country.

As a resident alien, you will file a Form 1040 or 1040-EZ return.

What are the tax implications for non-resident aliens?

If you’re a non-resident alien, you’re taxable by the U.S. only on the income (not including capital gains) that you earn in the U.S. Before the 2018 tax year, you would qualify for an annual personal exemption. But for tax years after 2017, the personal exemption is no longer allowed.

A non-resident alien’s U.S. taxable income includes:

• Income that is effectively connected with a trade or business in the United States

• U.S. source income that is fixed, determinable, annual or periodical (FDAP)

Effectively connected income is taxable at the same graduated rates applicable to U.S. citizens and resident aliens. FDAP income is taxed at a flat 30% rate (or possibly lower under a tax treaty, if applicable).

If you’re also taxed by your country of citizenship on your U.S. source income, you cannot claim a U.S. foreign tax credit like resident aliens can. You might seek double taxation relief under your home country’s tax law or a tax treaty (if any) between the U.S. and your home country.

Non-resident aliens must file a Form 1040NR or 1040NR-EZ tax return. If you don’t qualify for a Social Security number, you can apply for an Individual Taxpayer Identification Number.

Understanding the Non-Resident Alien Tax Trap

Proper tax planning is essential in recognizing future tax obligations and structuring ownership of assets in a way that minimizes estate and gift taxes owed.

Tax Treaties

If you’re a taxable resident or non-resident alien, you might be eligible for benefits under an applicable tax treaty between the U.S. and your country of citizenship. A tax treaty is a bilateral agreement between countries to cooperate on tax rules. This often helps people avoid paying taxes on the same income in two separate countries.

Most bilateral tax treaties conform to the Model Tax Convention published by The Organization for Economic Cooperation and Development (OECD). The Model treaty defines the types of income or capital that are taxable by the country of source — in this case, the United States. They include:

• Income from property located in the U.S. and gains from the sale of such property
• Gains from the sale of interests in an entity that is 50% owned by the taxpayer
• Remuneration for services rendered in the U.S. (provided the service provider is present in the U.S. for more than 183 days in any 12-month period)
• Income received by entertainers and sportspersons attributable to activities in the U.S.

Some categories are subject to limited tax:

• Dividends that are not connected to a permanent establishment may not be taxed at more than a 5% rate.
• Interest that is not connected to a permanent establishment may not be taxed at more than a 10% rate.

Article V of the OECD Model defines a “permanent establishment” generally as “a fixed place of business through which the business of the enterprise is wholly or partly carried on.”

Treaty Shopping: Limitation on Benefits

Most tax treaties with the U.S. include a provision known as the Limitation on Benefits (LOB) clause. This clause is designed to eliminate the practice of treaty shopping. Under this scheme, taxpayers will establish shell corporations in certain countries solely to take advantage of a tax treaty.

Generally, the LOB denies treaty benefits to those taxpayers whose residence in a contracting country is motivated by the benefits of a tax treaty. A non-resident alien should be advised as to the applicability of such LOB provisions.

Get help with your tax needs.

If you’re a non-resident alien doing business or working in the United States, you need the expert advice of an international tax specialist to guide you through the labyrinth of tax treaties and U.S. tax laws.

At James Moore & Co., our staff is highly experienced with tax treaties and U.S. taxation of foreign businesses. Contact us today for assistance with your tax needs so we can help your business grow.