Tax Rules of the Road

US tax rules are the most complex body of law and procedures in the world. The US federal tax rules consist of laws and income and estate tax treaties, plus regulations, rulings, notices, announcements, publications, forms and instructions issued by the Internal Revenue Service (IRS). The most complex and least well-defined tax rules are those that apply to transactions of foreign nationals. In all of its rulings and publications, the IRS fails to provide a framework so that taxpayers and their advisors can understand how to apply the tax rules to transactions of foreign nationals. The purpose of the "Tax Rules of the Road" is to provide you with that framework.

Rule One:
The general tax rule applies unless an exception is available, and the conditions for the exception, including procedural conditions, are met.

One general rule is that all compensation for employment services performed in the United States is subject to US social security and Medicare taxes (FICA). This is the case regardless of the location and currency of payment in most cases, because there is no blanket exception for employees paid outside the United States.

Rule Two:
The exception is not the general rule.

Tax laws typically include exceptions following the general rule. The exceptions may also have exceptions or conditions which can negate the exceptions.

One FICA exception is for nonresident aliens who are in F, J, M, or Q immigration status. Most individuals in such status assume that the general rule is that they are exempt from FICA, but that is not the general rule. The individual must meet all of the conditions of the exception in order to be exempt. For example, a J-2 dependent is not eligible for this exemption because the individual’s employment is not "consistent with the purpose that the individual entered the United States," which was to accompany the primary visa holder.

There are many Tax Highways, each with its own Rules of the Road such as:

• Federal income taxes
• State income taxes
• Federal estate and gift taxes
• State estate taxes
• Social security and Medicare taxes (FICA)

Taxpayers and advisors must know the Tax Highway that they are on in order to apply the Rules of the Road. For example, federal income tax law includes rules for determining when an individual is a resident alien and taxed like a US citizen; or a nonresident alien and taxed under special rules. These residency rules are the "green card" test and the "substantial presence test." However, the State Income Tax Rules of the Road define a resident for state income tax purposes. The residency rule for federal estate taxes is based on the concept of "domicile," but the residency rules for trust grantors, trustees, and beneficiaries are based on the federal income tax residency rules.

The FICA Rules of the Road include an exception for nonresident aliens in F, J, M, or Q status. However, the Federal Income Tax Rules of the Road define the term, "nonresident alien." An individual who meets either the "green card" or "substantial presence" test is a resident alien and, therefore, not eligible for the FICA exemption.

An individual may be entitled to use Rules of the Road provided by an income tax treaty. An estate executor may be able to use an estate tax treaty to reduce U.S. estate taxes.

Under an income tax treaty, a resident of the treaty country for income tax purposes may be exempt from federal income taxes on items of income covered by the treaty provided the treaty conditions are met and the individual follows the procedural rules required by the IRS for the exemption.

Treaties also include general rules with exceptions, and exceptions to exceptions. A good example is the "saving clause." Because the United States taxes its citizens and residents on worldwide income, tax treaties include an exception preserving the right of the United States to tax its citizens and residents as if the treaty did not come into effect. The saving clause includes exceptions for certain benefits, such as for students, trainees, teachers, and researchers. However, these exceptions are negated if the individual becomes a U.S. citizen or U.S. lawful permanent resident ("green card" holder).

Watch for Vol. 1, No. 2 for a further discussion of the Tax Rules of Residency and for future editions for more discussions about income tax treaties.

Q: I am a Canadian researcher in the United States in TN status. I think I should be exempt from FICA like all of my colleagues who are researchers. Why do I have to pay and they do not?

A: The general rule is that all compensation for employment services performed in the United States is subject to FICA tax unless an exception applies. There is an exception for nonresident aliens who are in F, J, M, or Q immigration status. Your researcher colleagues are in J-1 status, which is why they are eligible for the exemption and you are not. Also, you will become a resident alien under the substantial presence test, while your J-1 colleagues will typically be nonresident aliens for two tax years, another condition for the exemption.

Additions to the Windstar Crew

Don Buhan and Scott Liberman have joined Windstar as senior sales executives. Don will be working on the upcoming ERP interfaces and the hospital markets. Scott will be working in both the higher education and research institution markets.

Windstar Welcomes Aboard the Following New Clients

Calvin College, Columbia University, Dickinson College, Florida Atlantic University, The Forsyth Institute, Los Alamos National Laboratory, Marlboro College, New York University, Northeastern Ohio Universities College of Medicine, Philadelphia University, Salk Institute, Stowers Institute for Medical Research, University of Massachusetts Boston, University of Notre Dame, University of Denver, University of Okalahoma Health Science Center, University of Texas System Medical Foundation, University of Florida Research Foundation and Wayne State University.

New Tax Guidebooks Launched

Just published! A Guide to Filing IRS Forms 1042 and 1042-S and Tax Treaty Benefits for Foreign Nationals Performing U.S. Services are now available. These tax guides, incorporating all updates through 2003, offer easy-to-understand explanations of the complex tax rules that apply to payments to foreign persons.

Don’t miss the NRA Spring Training Session at the Marriott in Newton, MA on April 20 - 23! This is a great opportunity to learn about interfaces and the latest international tax developments.

April is a great time to visit Boston. Come early to see the Boston Marathon on April 19th, sample the Taste of the Back Bay at Wang Center for the Performing Arts, ride in the famous Swan Boats in Boston Gardens, see Boston By Foot: Beacon Hill Architectural Tour of The State House, or ride the Duck Tours thru historical downtown Boston.

To open up the training there's a special evening session with Paula Singer, Esq. on Tuesday, April 20 for International Tax Navigator® beginners at no extra cost.

On April 22, two tracks, beginner and intermediate, will be offered. Included in the intermediate track is an important afternoon session on Windstar Tax Navigator interfaces with guest experts on PeopleSoft, Oracle, and SCT Banner.

Hope to see you there!

©Copyright 2004 by Windstar Technologies, Inc. Windstar reserves all rights to this electronic material. You may not transmit this publication to others. Information contained in this publication is based on the best information available at the time of publication.  While believing the information in this publication to be accurate, Windstar accepts no legal responsibility for its accuracy.