Proper Tax Treatment of Foreign Hires Presented by Tax Services September 2006

Overview Tax Residency: What’s it all about? Identifying Foreign Hires Tax Residency Information Form & Documentation Taxing Nonresident Alien Employees

Tax Residency What is it? Why we care

Tax Residency Under U.S. tax laws, all non-U.S. citizens are considered to be either: Permanent resident aliens Resident aliens for tax purposes, or Nonresident aliens.

Taxation & Residency Permanent resident aliens and resident aliens for tax purposes are taxed the same as U.S. citizens Resident aliens generally are taxed on their worldwide income, the same as US Citizens Nonresident aliens are taxed under special laws Nonresident aliens are taxed only on their income from sources within the US & on certain income connected with the conduct of trade or business in the US.

Tax Residency - Why We Care Knowing an individuals tax residency status prior to payment is essential to accurately report the individual’s tax liability and to be in compliance with IRS tax laws.

Tax Residency - Why We Care If we incorrectly report a nonresident alien’s tax withholding liability, we may be held responsible for the tax not withheld, in addition to any penalties for failure to withhold, plus the interest from the time the tax was not withheld.

Identifying Nonresident Aliens State Employees

Identifying NRA Employees: I-9  I-9 : “An alien authorized to work until…” must fill out MNSCU TRIF form

Tax Residency Information Form Employee’s who indicate on their I-9 that they are “an alien authorized to work until…” must fill out the Payroll Tax Residency Information form. The data collected on this form will help determine an employee’s tax residency status

Tax Residency Information Form Section A: Personal Information Current Immigration Status Date Current Status Began Section B: Prior Visit Information Visits to the U.S. before Date Current Status began Section C: Employee Certification

Tax Residency Information Form

Tax Residency Information Form

Tax Residency Information Form

Tax Residency Information Form

TRIF Documentation Verify immigration status Copy immigration documentation Passport I-94, arrival/departure record, stamped Immigration Status documentation I-20, F-1 student on OPT DS-2019, J-1 (student or scholar) H-1B Approval Letter Invitation and Employment Letters Employment Authorization Cards (front and back) Any other immigration documentation presented by the payee

I-20 Certificate of Eligibility for Nonimmigrant (F-1) Student

I-94: Arrival/Departure Record

DS-2019 Certificate of Eligibility for Exchange Visitor(J-1) Status

I-94: Arrival/Departure Record

Passport Information Identification Page Current visa information Prior visits to US

Determining Tax Residency The Substantial Presence Test

Tax Residency Information Form

Tax Residency Tests There are two tests used to determine whether a non U.S. citizen should be treated as a U.S. resident for tax purposes: The “Green Card” test, and the Substantial Presence Test

The “Green Card” Test The individual is a lawful permanent resident alien if he/she: Has been granted lawful permanent resident status in the U.S., and Has been issued or will receive an alien registration card by U.S. Citizenship & Immigration Services (USCIS). Tax as U.S. Citizen

The Substantial Presence Test Mathematical calculation of days present in the U.S. used to determine tax residency. An alien individual will be considered a U.S. resident for tax purposes if they meet the SPT for the calendar year.

Substantial Presence Test Data Current Immigration Status Primary Purpose of U.S. Visit Date of Arrival for Purposes of Current Visit Information about Prior Visits including the above facts

Substantial Presence Test An alien individual will be treated as a resident alien for tax purposes if they are physically present in the United States on at least: All the days present in the current year, plus 1/3 of the days present in the first year before the current year, plus 1/6 of the days present in the second year before the current year. 31 days during the current year, and 183 days during the 3 year period that includes the current year and the 2 years immediately preceding, calculated as follows:

Substantial Presence Test & Taxation If SPT is met, Tax as a Resident If SPT is not met, Tax as a Nonresident

Substantial Presence Test Example A Lorena was physically present in the U.S. for: 138 days in 2004, 129 days in 2005, and 120 days in 2006, Q: Does Lorena meet the substantial presence test for 2006?

SPT Example A Q: Does Lorena meet the substantial presence test for 2006? In the U.S. for over 31 days in the current year Apply the 183 day test as follows: 2006: 120 days 2005: (129 x1/3) = 43 days 2004: (138 x 1/6) = 23 days Total days present in U.S. = 120 + 43 + 23 = 186 days

SPT Example A Ans: Yes, Lorena is considered a resident alien for tax purposes because: She has been present in the U.S. for over 31 days in current calendar year, and Her total number of days in the U.S. for the three-year period as calculated by the substantial presence test was over 183 days.

Days Not Counted Exceptions to counting days towards substantial presence: Any days the individual regularly commutes to work in the U.S. from a residence in Canada or Mexico Any days the individual is in the U.S. for less than 24 hours when in transit between two places outside of the U.S. Any days the individual was unable to leave the U.S. due to a medical condition that developed while he was in the U.S., and Any days the individual was present in the U.S. as an “exempt individual”.

Exempt Individuals “Exempt individuals” are present in the U.S. for the primary purpose of being: a teacher or trainee generally present under a “J” or “Q” visa; includes all “J” non-student categories a student generally present under a “F”, “J”, “M” or “Q” visa a “foreign government-related” individual generally a foreign diplomat or consular officer present under an “A” or “G” visa a professional athlete generally present under a “P” visa

Exempt Individual: Rules F, J, M or Q student visa holders will not qualify for “exempt individual” status if they have had that status for any part of more than five calendar years. J or Q non-student visa holders will not qualify for “exempt individual” status if they were exempt as a teacher, trainee, non-student or student for any 2 of the last 6 calendar years.

SPT & Exempt Individual: Mei Lee Mei Lee, a Chinese citizen, has never been to the United States before. She arrives in the U.S. under a J-1 visa on December 15, 2006 to work at Minnesota State University, Mankato. As a J-1 scholar, Mei Lee is an exempt individual in calendar year 2006 & calendar year 2007. Mei is a nonresident alien for tax purposes. J-1 NRA: Exempt for FICA/Medicare taxation Eligible for J-1 Teaching/Researching Tax Treaty W-4 - Statutory withholding

Taxing Nonresident Aliens Statutory Withholding FICA Exemption Tax Treaty Benefits

Example: Taxing Mei Lee NRA J-1 Scholar = Exempt from FICA/Medicare Taxation U.S. – China Tax Treaty Benefit Article 19 of US-China Tax Treaty 3 Years, No income limit IRS Form 8233 Year End Reporting IRS Form 1042-S

Statutory Withholding Rules Nonresident Aliens & W-4: May not claim exemption from income tax withholding, Request withholding as if they are single, regardless of their actual marital status, Claim only one allowance, unless an exception exists, and On line 6, write “Nonresident Alien” or “NRA”

W-4 Witholding Allowance Nonresident Alien Mei Lee 12/16/2006

Exceptions to Statutory Withholding Rules Students from India Article 21(2) of the United States-India Income Tax Treaty An additional withholding allowance may be claimed for a spouse if the spouse has no U.S. source gross income and may not be claimed as a dependent by another taxpayer. An additional withholding allowance for each dependent (usually a child) who has become a resident alien. Canada and Mexico, American Samoa and Northern Mariana Islands Entitled to claim additional withholding allowances for a nonworking spouse and for dependents, the same as a U.S. citizen. South Korea May claim additional withholding allowances for a nonworking spouse and dependents present with them in the U.S.

FICA Exception for F, J, M & Q Nonresident Aliens IRC Section 3121(b)(19) An individual may be exempt from FICA tax withholding if he or she meets all of the following criteria: Is a nonresident alien for taxation purposes (i.e.: has not met the substantial presence test); Is present in the U.S. under a F, J, M or Q visa; Is performing services in accordance with the primary purpose of the visa’s issuance (i.e., the primary holder of the visa, the “-1”). This exemption does not apply to F, J, M or Q visa holders who become resident aliens for tax purposes (i.e., individuals who have met the substantial presence test).

Tax Treaties & Income Withholding Agreement between two countries to reduce or eliminate double taxation. US has income tax treaties with over 48 different countries Each treaty is unique and may not contain the same provisions or exemptions as another tax treaty. From time to time, treaties with additional countries are signed and existing treaties revised IRS website has complete text of current tax treaties Exemption from Income Tax Withholding based on Treaty Benefits An income tax treaty is a bilateral legal agreement between two countries to reduce or eliminate double taxation. The United States maintains bilateral income tax treaties with over 48 different countries in an effort to reduce or eliminate double taxation. It is important to note that each individual treaty is unique and may not contain the same provisions or exemptions as another tax treaty. From time to time, treaties with additional countries are signed and existing treaties revised. About half the tax treaties contain a limited exemption for dependent personal service income earned by employees while in the U. S. In general, tax treaty benefits will be applicable only to those MnSCU employees holding TN, F-1, J-1 or H-1B visas. There is typically an annual maximum dollar amount and/or a time limit of presence in the U.S. for which the exemption can be claimed. Example A: Under Article XV of the U.S.-Canada income tax treaty, income that residents of Canada receive for personal services performed as employees in the U.S. is exempt from U.S. tax if it is not more than $10,000 per year. If the employee earns more than $10,000 for the year, the entire amount is taxable. Thus the Canadian taxpayer who expects to earn more than $10,000 in the year should avoid claiming the treaty benefit. Tax Treaties and Educators Pay of professors and teachers may be exempt from U.S. income taxes for either 2 or 3 years if they are temporarily in the U.S. to teach or do research. The treaty exemption for teaching or research income is counted from the day of arrival in the U.S. Some countries have retroactive clauses stating that if the maximum years of presence are exceeded, the entire treaty benefit is lost. This could require the teacher to file amended returns and pay tax on past years income. Thus a taxpayer who expects to stay more than the limit of years of presence should avoid claiming the treaty benefit for any years. Example B: Deepak is from India. He is on a J-1 visa and is teaching physics at Minnesota State, Mankato. He has been hired on a 4 year contract. Under the U.S.-India tax treaty, Article 22, a professor or teacher who is a resident of India immediately before visiting the U.S. and is in the U.S. to teach at an accredited university or educational institution for a period of not longer than 2 years is exempt from U.S. income tax on income received for teaching. The U.S.-India tax treaty contains a retroactive clause that states if a professor or teacher remains in the U.S. for more than the specified two-year period, they may be subject to tax for the entire period of their presence in the U.S. Since Deepak expects to stay beyond the maximum years of presence allowed by treaty, he should not claim the treaty benefit for any year. Example C: Assume the same facts as above, except that Deepak stays only one year and then returns to India. He is entitled to the treaty benefit, even though his original contract exceeded the limit on years of presence. Deepak would claim the treaty benefit with his 1040NR tax return. For the complete text of current tax treaties, go to the IRS website. The direct link to the tax treaty page is: http://www.irs.gov/businesses/corporations/article/0,,id=96739,00.html.

Tax Treaties & Income Withholding Typically, the employee must be a nonresident alien for tax purposes to claim treaty benefits J-1 Scholar Tax Treaty Article/Clause Teaching/Researching Dependent Personal Services (Canadian) Annual maximum dollar amount and/or a time limit of presence in the U.S.

Example: Taxing Mei Lee NRA J-1 Scholar = Exempt from FICA/Medicare Taxation U.S. – China Tax Treaty Benefit Article 19 of US-China Tax Treaty 3 Years, No income limit IRS Form 8233 Year End Reporting IRS Form 1042-S

Form 8233: For Claiming Treaty Benefits

Completing Form 8233

Form 8233: Page 2

8233 Statement Attachment People’s Republic of China I was a resident of the People’s Republic of China on the date of my arrival in the United States. I am not a U.S. citizen. I have not been lawfully accorded the privilege of residing permanently in the United States as an immigrant. I have accepted an invitation by the U.S. government, or by a university or other recognized educational institution in the United States to come to the United States for the purpose of teaching or engaging in research at Minnesota State University, Mankato, which is an accredited educational institution or scientific research institution. I will receive compensation for my teaching, lecturing, or research activities. The teaching, lecturing, or research compensation received during the entire tax year qualifies for exemption from withholding of federal income tax under the tax treaty between the United States and the People’s Republic of China. I have not previously claimed an income tax exemption under this treaty for income received as a teacher, lecturer, researcher, or student before the date of my arrival in the United States. Any research I perform will be undertaken in the public interest and not primarily for the private benefit of a specific person or persons. I arrived in the United States on 12/15/2006 [insert the date of your last arrival in the United States before beginning the teaching or research services for which the exemption is claimed]. The treaty exemption is available only for compensation received during a maximum aggregate period of three years. Tax year treaty being claimed for 2007_; Under penalties of perjury, I declare that I have prepared this form and to the best of my knowledge and belief, it is true, correct, and complete. Signature of nonresident alien individual_Mei Lee __________Date __12/16/2006_________

SEMA4 & Nonresident Aliens SEMA4 Bulletin 7/13/2006 SEMA4 Tax Treaty Field Informational only Retirement & Foreign Hires Contact Gary Janikowski,System Director, Personnel, 651-297-5540

Questions?

Contact Information Tax Services Website: http://www.financialreporting.mnscu.edu/Tax_Services/index.html Ann Page, 651-632-5007 Ann.Page@so.mnscu.edu Steve Gednalske, 651-632-5016, Steve.Gednalske@so.mnscu.edu