Nonresident Alien Withholding - Effectively Connected Income

[DTH]

This plan has nonresident aliens who live and work in the U.S. while participating in the plan. If the participant terminates employment and the individual is residing in the U.S., the normal U.S. withholding rules apply.

If the participant has contributions and earnings that are all effectively connected income (worked and contributed to the plan after 12/31/86) and moves back to their resident country can the individual claim a lower treaty rate on effectively conntected income? How does the payor withhold?

1. Normal U.S. withholding only;

2. 30% withholding only;

3. 30% withholding unless there is a lower treaty rate. For the individual to request a lower treaty rate what form does the individual provide the payor ... Form 8233??;

4. 30% withholding and can request a lower U.S. graduated rate by providing payor with Form W-8ECI; or

5. 30% withholding unless there is a lower treaty rate (same as #3. above). If there is no lower treaty rate, the individual can request the lower U.S. rate (using Form W-8ECI).

Help! Thanks

[mbozek]

The income is taxed at the treaty rate. As a general rule income earned by a citizen of another country with which the the US has a tax treaty is usually taxed only by the foreign country and is exempt from US income tax. There is an IRS publication on tax treaties with foreign countries which should be consulted to determine what is the correct withholding rate.

[DTH]

Thanks Mbozek. So .... my withholding scenaio #5 applies. I just want to confirm that the individual needs to provide the payor with Form 8233 for the reduced treaty rate. If U.S. graduated rate is lower than treaty rate, the individual provides form W-8ECI.

Thanks!

[Kirk Maldonado]

Pardon my ignorance, but how do you have a nonresident alien who is living and working here? Doesn't that make him or her a "resident" alien?

[mbozek]

Resident aliens are non US citizens who have a legal right to permanent residence in the US, e.g., they are married to a US citizen. A resident alien is subject to both US income for all income and US gift/estate tax laws. A non resident alien is a non citizen who has the right to live/work in the US for a period of time but then must return to his /her own country or may have a residence in the US. Non resident aliens are subject to us income tax for US source income but not US estate/gift taxation. US taxation of non citizens may be modified / eliminated under a tax treaty.

[Kirk Maldonado]

MBozek:

Thanks for the clarification.

[Guest Harry O]

But Kurt's question is still a good one . . .

For INCOME tax purposes, a nonresident alien becomes a resident alien (taxable on worldwide income) once he is in the U.S. for more than 183 days. A different rule applies for estate tax purposes (residence based on a domicile analysis).

Its hard to imagine how you could have someone WORKING in the US on a non-immigrant visa, participating in a 401(k) plan, and not be a resident alien for income tax purposes.

Seem like we either have tax law violations or immigration law violations.

[mbozek]

H- Many US tax treaties provide that foreign nationals are exempt from US taxation if the foreign country exempts us citizens from taxation. Need to review the IRS publication on tax treaties for each country. Also non a US citizen (including a resident alien) who is married to a US citizen is not eligible for the unlimited marital deduction under the Estate and Gift tax laws. Gifts are limited to $110,000 per year and the estate tax exclusion is $1,000,000.

[Guest Harry O]

I don't want to get into an extended discussion of international taxation but some final observations:

1. Many treaties don't apply to termination of employment distributions where the employee receives a lump sum and is not at least age 55. Most require periodic payments or payments made after terminating employment after a certain age.

2. I'm not aware of any treaty provision that would exempt a nonresident alien working in the US for an extended period of time (generally more than 183 days) from current US taxation. I would be interested to know of any . . .

[mbozek]

The 1996 US model tax treaty explicitly includes lump sum distributions in addition to periodic payments. Also the 1995 US- France tax treaty now includes lump sum payments as well as periodic distributions as being subject to taxation only by the country of residence of the employee who earned the benefits. YOu should check the IRS publicaton on tax treaties for a complete listing.