U.S. Income Taxation of Nonresident Alien Individuals (Portfolio 6400)

To the extent that nonresident aliens are subject to U.S. income tax, their U.S. taxable income is divided into one of two categories: (i) U.S.-source income that is not “effectively connected” with the conduct of a trade or business within the United States, taxable at the rate of 30% under §871(a) without the allowance of deductions; and (ii) income that is “effectively connected” with a U.S. trade or business, taxable at graduated rates on a net basis under §871(b). However, numerous special exceptions and rules apply for specific types of income.

Whether an alien is classified as a resident alien or a nonresident alien is based on detailed rules in §7701(b) and the regulations thereunder. For the most part, these rules are “mechanical,” so that in most factual situations it is possible to know with certainty whether a particular alien is a resident alien or a nonresident alien on a particular day. The rules in §7701(b) may be overridden by the “tie-breaker” provisions of a tax treaty, however, where it is shown that an alien is also classified as an income tax resident of another country having an income tax treaty with the United States. Special issues arise concerning the IRS reporting forms that may have to be filed by individuals who are classified as resident aliens under the Code but as nonresident aliens by virtue of a treaty tie-breaker provision.

If a nonresident alien realizes U.S.-source income subject to tax on a gross basis, payments related to that income are normally subject to withholding tax at a 30% rate under §1441. Where a nonresident alien is taxable on a net basis on income that is effectively connected with a U.S. trade or business, he/she must file a federal income tax return on Form 1040NR, U.S. Nonresident Alien Income Tax Return. The calculation of the alien's taxable income and of the alien's tax is similar to the rules for U.S. citizens and resident aliens, but with certain important differences. Special rules can apply where an alien comes to the United States to work, becomes a resident, and later receives deferred compensation or pension income from the United States after moving abroad and resuming nonresident alien status.

Many nonresident aliens who are present in the United States and who plan to depart from the United States are required to make a personal visit to an IRS office and apply for a so-called “tax clearance certificate” (or “sailing permit”).

Nonresident aliens who plan to move to the United States and who anticipate becoming resident aliens should always consider advance planning in order to take advantage of certain elections under the Code, as well as avoid potential pitfalls.

This Portfolio may be cited as Bissell, 6400 T.M., U.S. Income Taxation of Nonresident Alien Individuals.