Form 1040NR Non-Resident Alien Filing Requirements...

Form 1040NR Non-Resident Alien Filing Requirements:

Challenges for Tax Preparers

TUESDAY, JANUARY 29, 2012, 1:00-2:50 pm Eastern

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U.S. Taxation of Foreign Investors

Non Resident Alien Individuals & Foreign Corporations

By

Richard S. Lehman Esq.

TAX ATTORNEY www.LehmanTaxLaw.com

4

Richard S. Lehman Esq. Richard S. Lehman has over 38 years of practicing tax law in the

United States.

Mr. Lehman has had extensive experience with all areas of the

Internal Revenue code that apply to American taxpayers and

nonresident aliens and foreign corporations investing or conducting

business in the United States, as well as U.S. citizens and domestic

corporations investing abroad.

Richard Lehman began his career in tax law with a law degree from

Georgetown University, a Master’s Degree in tax law from New York

University, and two years of clerking for the Honorable William M.

Fay, a Judge on the United States Tax Court in Washington, D.C. He

spent several years as the senior attorney of the Interpretive Division

of the Chief Counsel’s office at the Internal Revenue Service, the

IRS's internal law firm.

Today, Richard works with other lawyers, accountants, business

leaders and individuals who are struggling to find their way through

the complexities of United States Tax Law. 5

Define The Foreign Investor

– Non Resident Alien Individual

A non U.S. citizen individual who is NOT a Resident Alien

NOTE: Resident Alien (Resident for U.S. Income Tax Purposes)

– Foreign Corporations

A Foreign Corporation is any corporation that is not formed in the

United States or under the laws of the United States or any state.

6

TAXATION PATTERN

U.S. Resident Alien ("Tax Resident") - Subject to Taxation

1. Income Taxation - Worldwide Income

2. Estate Taxation - Worldwide Assets

3. Gift Taxation - Worldwide Assets

7

Non Resident Alien

Individual Investor – Subject to Taxation

1. Income Taxation - United States source income,

limited type of foreign Source income

2. Estate Tax - United States Situs assets only

(includes real estate)

3. Gift Tax - real and tangible personal property with a

United States Situs

4.

**Branch Tax - Corporations only

8

STATUS FOR TAX PURPOSES

A. Non-Resident Alien - Not a “Resident Alien”

B. Resident for Income Tax Purposes

1. Green Card

2. Substantial Presence Test

3. Voluntary Election

Exceptions:

4. The Closer Connection

5. Treaties: Tie Breaker

C. Foreign Corporations

9

Substantial Presence Test

10

TWO TYPES OF FEDERAL INCOME

TAXATION PATTERNS Foreign Taxpayer

Foreign Investors (both Alien Individuals and Foreign Corporations) pay U.S. tax on U.S. income in two entirely different ways depending upon whether the income the Foreign Taxpayer earns is from "passive" sources or whether the income results from the Foreign Taxpayer's conduct of an “active trade or business” in the U.S.

Source of Income Rules 1. U.S. Source Income

2. Foreign Source Income

3. Deductions

Taxation of Passive (Non Business Income) 1. 30% Flat Tax Rate - Gross Income

2. Withholding Obligations and Contingency

Taxation of Active Trade or Business Income 1. Graduated Corporate Tax Rates

2. Graduated Income Tax Rates

3. Effectively Connected Income

4. Income Effectively Connected with a U.S. Business

Treaties

11

SEVERAL IMPORTANT EXCEPTIONS

Capital Gains Taxation

Alien Individual = individual tax rates and generally no tax on capital gains

Foreign Corporation = corporate tax rates and generally no tax on capital gains

Estate Taxation 1. Alien Individual - Residency for Estate Tax Purposes

2. Non Resident Tax Rates

3.

U.S. Real Property

1. U.S. companies holding U.S.Real Property and the U.S. Estate and Gift taxes

The Branch Profits Tax (Foreign Corporation Only)

Foreign Corporation 1. U.S. Trade or Business

2. Foreign Source Income

12

Unlike a Foreign Taxpayer that is

taxed on passive U.S. source

income only…

Income of a Foreign Taxpayer that conducts a trade or business

in the U.S. will pay tax on all of its United States source income

and in limited circumstances, U.S. tax must be paid on income

that is earned from foreign sources and not U.S. sources.

Foreign source income that is attributable to a Foreign

Taxpayer's U.S. trade or business activity may be taxed by

the U.S. and is called "Effectively Connected Income".

13

Source of Income Rules

a. U.S. Source Income

b. Foreign Source Income

c. Deductions

There are a strict set of rules that govern the determination

of whether income finds its source in the United States or a

foreign place for U.S. tax purposes.

14

Source of Income

1. Compensation for personal services. The source of income from the

personal services is located at the place where the services are performed.

2. Rents and Royalties: Rent or royalty income has its source at the location,

or place of use, of the leased or licensed property.

3. Real Properly Income and Gain: Income and gain from the rental or sale of

real estate has its source at the place where the property is situated.

4. Sale of Personal Property: Historically, gain from the sale of personal

property has been sourced at the “place of sale” which is generally held to

be the place where title to the goods passes; however, the rules have

become more complex taking other factors in place.

15

5. Interest. The source of interest income is generally determined by

reference to the residence of the debtor; interest paid by a resident of

the United States constitutes U.S. source income, while interest paid

by foreign residents is generally foreign-source income.

6.

6. Dividends. The source of dividend income generally depends on the

nationality or place of incorporation of the corporate payer; that is,

distributions by U.S. corporations constitute domestic-source income,

while dividends of foreign corporations are foreign-source income.

There are, however, several important exceptions to these rules.

7.

Source of Income

16

Slide Intentionally Left Blank

THE EFFECT OF BILATERAL TREATIES -

EXTREMELY IMPORTANT BENEFITS

Tax treaties between the U.S. and other countries can operate to;

1. reduce (or even eliminate) the rate of U.S. tax on certain

types of U.S. income derived by Foreign Taxpayers situated

in the treaty-partner country;

2. override various statutory source of income rules

3. exempt certain types of income or activities from taxation,

by one or both treaty-partner countries; and

4. extend credit for taxes levied by one country to situations

where the domestic law would not so provide.

18

United States Taxation of Foreign Investors

Richard S. Lehman, Esq.

6018 S.W. 18th Street, Suite C-1

Boca Raton, FL 33433

Tel: 561-368-1113

Fax: 561-368-1349

Skype: LehmanTaxLaw

www.LehmanTaxLaw.com

19

© 2013 McGladrey LLP. All Rights Reserved. © 2013 McGladrey LLP. All Rights Reserved.

By Carolyn R. Turnbull, CPA, MST

Tax Director, McGladrey LLP

Form 1040NR Non-Resident Alien Filing

Requirements: Challenges for Tax Preparers


INTRODUCTION


Introduction

Determine the taxpayer’s U.S. resident or

nonresident alien status at the end of the tax year

What form to file?

- Form 1040?

- Form 1040NR?

- Form 1040NR-EZ?

When to file?

Where to file?

File Form 1040X to amend Form 1040NR or Form

1040NR-EZ

23


Introduction – cont.

Potential penalties - Civil penalties

• Failure to file

• Late payment of tax

• Accuracy-related penalties

• Fraud

• Filing erroneous claim for refund or credit

• Frivolous tax submission

• Failure to supply taxpayer identification number

- Criminal penalties

• Tax evasion

• Will failure to file a return, supply information, or pay any tax due

• Fraud and false statements

• Preparing and filing a fraudulent return

• Identity theft

- Penalty for failure to disclose a treaty position by filing Form 8833

24


IRS Publications

Publication 15 (Circular E), Employer’s Tax Guide

Publication 17, Your Federal Income Tax

Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad

Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities

Publication 519, U.S. Tax Guide for Aliens

Publication 597, Information on the United States-Canada Income Tax Treaty

Publication 901, U.S. Tax Treaties

25


WHO MUST FILE FORM

1040NR


Who Must File Form 1040NR?

Any of the following apply:

- Filer is an NRA engaged or considered to be engaged in a

U.S. trade or business during the year;

- Filer is an NRA not engaged in a U.S. trade or business

and

• Received income from U.S. sources reportable on

Schedule NEC, and

• Not all U.S. tax owed was withheld.

- Filer represents a decedent who would have been

required to file Form 1040NR.

- Filer is a fiduciary for an estate or trust required to file

Form 1040NR.

27


Who Must File Form 1040NR?

NRA owes any special taxes (e.g., AMT or recapture of first-time homebuyer credit)

NRA receives HSA, Archer MSA, or Medicare Advantage MSA distributions

NRA has at least $400 of self-employment earnings and is a resident of a country with whom U.S. has an international social security agreement.

NRA wants to claim a refund of overwithheld or overpaid tax

NRA wants to claim the benefit of any deductions or credits (e.g., deductions against income from real property that he/she is choosing to treat as ECI)

28


Exceptions for Filing Form 1040NR

NRA ‘s only U.S. trade or business was performance of personal services, and

- Wages are less than the personal exemption ($3,800 for 2012), and

- NRA has no need to file a return –

• To claim refund of overwithheld taxes,

• Satisfy additional withholding at source, or

• Claim full or partial exemption for income under an income tax treaty.

NRA was a student, teacher, or trainee temporarily present in the U.S. under an “F”, “J”, “M”, or “Q” visa, and NRA has no income subject to tax under §871.

NRA is a partner in a U.S. partnership not engaged in a U.S. trade or business during the year and NRA’s Schedule K-1 (Form 1065) includes only income from U.S. sources reported on Schedule NEC

- NRA must file Form 1040NR if U.S. taxes are over or under withheld.

29


Other Forms NRA May Have to File

Form 8833, Treaty-Based Return Position

Disclosure Under Section 6114 or 7701(b)

Form 8840, Closer Connection Exception

Statement for Aliens

Form 8843, Statement for Exempt Individuals and

Individuals With a Medical Condition

Form 8938, Statement of Specified Foreign

Financial Assets

Form 8854, Initial and Annual Expatriation

Statement

30


NONRESIDENT ALIEN


Days of Presence in the United States

General Rule

- Days of presence includes any day the alien is physically present in the U.S. at any time during the day.

Exceptions

- Regular commuters from Canada or Mexico

- Days in transit between U.S. and foreign destination

- Crewe members of a foreign vessel

- Days that forced the alien to remain in the U.S. because of a medical condition that developed with the alien was in the U.S.

- Days the alien was an exempt individual

• File Form 8843.

32


Exempt Individuals

Foreign government-related individual temporarily

present in the U.S. under an “A” or “G” visa

Teacher or trainee temporarily present in the U.S.

under a “J” or “Q” visa who substantially complies

with the terms of the visa

Student temporarily present in the U.S. under an

“F”, “J”, “M”, or “Q” visa who substantially complies

with the terms of the visa

Professional athlete temporarily present in the U.S.

to compete in a charitable sports event

33


Closer Connection to a Foreign Country

General Rule

Alien who meets the substantial presence test can be treated as an NRA if the individual:

- Is present in the U.S. < 183 days during the tax year;

- Maintains a tax home in a foreign country during the tax year; and

- Has a closer connection during the tax year to one foreign country in which the individual has a tax home than to the U.S.

• Exception: Individual has a closer connection to two (but not more than two) foreign countries.

File Form 8840.

Certain foreign students can use closer connection exception even if present in the U.S. ≥ 183 days during the tax year.

- Foreign student files Form 8843 to claim closer connection exception.

34


Establishing a Closer Connection to a Foreign

Country

Individual has closer connection to foreign country if individual or Commissioner establishes that the individual has maintained more significant contacts with the foreign country than the U.S.

Fact and circumstances to be considered:

- Country individual designates as his/her residence on forms and documents

- Types of official documents the individual files (e.g., Form W-9, Form W-8BEN, or Form W-8ECI)

- Location of individual’s permanent home

- Location of individual’s family

- Location of personal belongings

- Individual’s current social, political, cultural, professional, or religious affiliations

- Individual’s business activities (other than those that constitute the individual’s tax home)

- Where the individual holds a driver’s license

- Where the individual is registered to vote

- Charitable organization to which the individual contributes

36


Establishing a Closer Connection to a Foreign

Country – cont.

Closer connection is unavailable if:

- Individual has personally applied or taken steps during the year to

change his/her status to U.S. permanent resident; or

- Individual has an application pending during the year for adjustment of

status.

37


DUAL-RESIDENT TAXPAYERS


Dual-Resident Taxpayers and Coordination

with Income Tax Treaties

Dual-resident taxpayer is a person who is a resident of the

U.S. and another country under the laws of each country.

Dual-resident claiming treaty benefits files Form 1040NR or

Form 1040NR-EZ as an NRA.

- Income tax treaty must contain tie-breaker rules

Taxpayer must file Form 8833 if he/she determines residency

under an income tax treaty and receives income or payments

> $100,000.

Dual-resident may be required to file Form 8938.

39


DUAL-STATUS TAXPAYERS


Dual-Status Taxpayers

Taxpayer is dual-status taxpayer if taxpayer is both an NRA and a resident alien during the same year.

- Most common in the year the taxpayer arrives in or departs from the U.S.

U.S. tax return filing requirements

- Dual-status taxpayer separates income between income while a U.S. resident and income while an NRA.

• Files Form 1040 with Form 1040NR statement if a resident alien on last day of the tax year.

• Files Form 1040NR with Form 1040 statement if an NRA on last day of the tax year.

- Dual-status taxpayer is subject to U.S. tax on worldwide income while a U.S. resident alien.

- Dual-status taxpayer is subject to U.S. tax on U.S.-source or U.S. ECI received during part of the year while an NRA.

41


Special Rules for Dual-Status Taxpayers

May not claim the standard deduction, even for the part of the year the individual is a U.S. resident.

May not claim Head of Household or use Schedule D of the Tax Computation Worksheet.

May not file a joint return unless individual elects to be taxed as a resident alien rather than a dual-status taxpayer.

Tax rates

- Dual-status taxpayer who is married at the end of the year and does not elect to file a joint return must use married filing separate rates.

- May be able to use single rates if:

• Taxpayer lived apart from his/her spouse during the last 6 months of the tax year, and

• Taxpayer is a married resident of Canada, Mexico, or South Korea, or a married U.S. national.

42


Special Rules for Dual-Status Taxpayers –

cont.

Exemptions

May claim personal exemption for him- or herself.

May only claim personal exemptions for spouse and

dependents for part of the year taxpayer is a U.S.

resident.

Special rules apply for part of the year a dual-status

taxpayer is a nonresident if taxpayer is:

- A resident of Canada, Mexico, or South Korea;

- A U.S. national; or

- A student or business apprentice from India.

43


Special Rules for Dual-Status Taxpayers –

cont.

Tax Credits

Dual-status taxpayer may not claim the following tax credits:

- Earned income tax credit;

- Credit for elderly or disabled; or

- Education tax credits.

44


First Year of Residency for Dual-Status

Taxpayers

If an individual is a U.S. resident alien during the current

calendar year but was not a U.S. resident alien at any time

during the preceding calendar year, the individual is a U.S.

resident for only the part of the year that begins on the

residency starting date.

- The individual is a nonresident alien for the part of the year

before that date.

45



Taxpayers

Residency Starting Date for Substantial Presence Test

General rule: Residency starting date is first day individual is present in the U.S. during the calendar year.

Up to 10 days of actual presence in U.S. may be disregarded.

- Individuals must have closer connection to and tax home in same foreign country on those days.

- Individual who is a U.S. resident because of the substantial presence test and who qualifies to use an early termination date may exclude up to 10 days of physical presence in the U.S. in determining the individual’s residency termination.

- Days are included in calculating the substantial presence test.

- Must file statement with the IRS to apply 10-day exclusion.

46



Taxpayers

Residency Starting Date for Green Card Test

If individual meets green card test but not substantial

presence test during the calendar year, residency starting date

is first day individual is present in the U.S. as lawful

permanent resident.

If individual meets both green card test and substantial

presence test during the calendar year, residency starting date

is earlier of first day during the calendar year the individual is

present in the U.S. under the substantial presence test or as a

lawful permanent resident.

47



Taxpayers

Residency During Preceding Year (“No Lapse” Rule)

An individual who was a U.S. resident during any part of the

preceding calendar year and who is a U.S. resident for any

part of the current year will be considered a U.S. resident at

the beginning of the current year.

- Rule applies regardless of whether an individual is a U.S. resident under

the substantial presence test or green card test.

48


First-Year Election (§7701(b)(4)

An individual who does not meet the either the green card or the substantial presence test for either the current calendar year (2012) (the “election year”) or the immediately preceding calendar year (2011), but who meets the substantial presence test for the following calendar year (2013), may elect to be treated as a resident of the U.S. for part of the current calendar year (2012) if the individual satisfies both of the following conditions:

- Individual was present in the U.S. ≥ 31 days during the election year; and

- Individual was present in the U.S. ≥ 75% of number of days beginning with first day of the 31-day period and ending last day of election year.

• Individual may treat up to 5 days of absence from the U.S. as days of presence in the U.S. for purposes of this 75% requirement

• Certain days may not be counted for purposes of the 31 days and 75% requirements, above.

49



Residency Starting Date

Residency starting date during the election year is the first day

of the earliest 31-day period that the individual uses to qualify

under 31-day test, above.

If individual is present in the U.S. for more than one 31-day

period and the individual satisfies the 75% requirement,

above, for each one of those periods, the individual’s

residency starting period is the first day of the first 31-day

period.

If an individual is present in the U.S. for more than one 31-day

period, but the individual satisfies the 75% requirement for only a

later 31-day period, the individual’s residency starting date is the first

day of the later 31-day period.

50



Procedures for Making First-Year Election

See Appendix

51


Last Year of Residency for Dual-Status

Taxpayers

U.S. resident who is not a U.S. resident during any part of the

following year ceases to be a U.S. resident on the residency

termination date.

“No lapse” rule

- Individual will be treated as a U.S. resident for the entire calendar year if

the individual is a resident during any part of the following calendar year.

53



Taxpayers

Early Residency Termination Date

Individual may qualify for earlier residency termination date

than December 31 under following circumstances:

- May use last day individual was physically present in the U.S. if

individual met substantial presence test.

- May use first day no longer a lawful permanent resident of U.S. if

individual met the green card test.

- May use later of two dates, above, if individual met both the substantial

presence and green card tests.

Individual qualifies to use an early residency termination date

if the individual had a tax home in a foreign country and a

closer connection to that foreign country for the remainder of

the last year of the individual’s U.S. residency.

54



Taxpayers – cont.

De Minimis Presence for Early Residency Termination Date

Individual who is a U.S. resident because of the substantial presence test and who qualifies to use an early termination date may exclude up to 10 days of physical presence in the U.S. in determining the individual’s residency termination date.

Individual can exclude days from more than one period, but total number of days in all periods may not exceed 10 days.

Individual cannot exclude any days in a period of consecutive days unless the individual can exclude all of the days in the period.

Individual must include any days the individual excludes in determining the residency termination date in determining whether the individual meets the substantial presence test.

Individual must file a statement with the IRS to establish his/her U.S. residency termination date.

55


Election to Treat Nonresident Spouse as U.S.

Resident (§6013(g))

Qualifications for §6013(g) election

- Taxpayers are married at the end of the tax year.

- One of the spouses is a U.S. citizen or U.S. resident at the end of the tax year.

Consequence of §6013(g) election

- Both spouses are treated as U.S. residents for entire year of election and all subsequent years unless the election is suspended or terminated.

- Both spouses are taxed on worldwide income.

- Neither spouse can claim they are not U.S. residents under a tax treaty.

- Spouses must file a joint return for the year of the election.

- Neither spouse may make a §6013(g) election for any later year, even if they separate, divorce, or remarry.

See Appendix for procedures for making a §6013(g) election.

- Election can be made on an amended return.

56



Resident (§6013(g)) – cont.

Suspension of §6013(g) Election

Election is suspended for taxable year if neither spouse is a U.S. spouse (e.g., both spouses are NRAs) during the year.

- Effect is that neither spouse may file a joint return during the suspension.

Death of a spouse

- If either spouse dies during any taxable year for which an election under §6013(g) is in effect, other than the first taxable year for which the election is to be in effect, the taxable year shall include, solely for purposes of determining whether an election is in effect only those days during the taxable year during which both spouses are alive.

• If U.S. spouse dies, election is not suspended for that taxable year.

• If NRA spouse dies, election is not suspended for that taxable year.

• If neither spouse was a U.S. citizen or resident during the period of the taxable year when both spouses were alive, the election is suspended for that year even if the surviving spouse subsequently acquires U.S. citizenship or residency

57



Resident (§6013(g)) – cont.

Termination of §6013(g) Election

Sec. 6013(g) election terminates upon earliest of the

following events:

- Either spouse revokes the election;

- The death of either spouse;

- Spouses legally separate under a decree of divorce or

separate maintenance; or

- Termination of the election by the IRS.

See Appendix for effective date of termination.

58


Electing U.S. Resident Alien Status (§6013(h))

Dual-status taxpayer can elect to be treated as U.S. resident alien for entire taxable year if all of the following are met:

- Individual is an NRA at the beginning of the year;

- Individual is a resident alien or U.S. citizen at the year of the year;

- Individual is married to a U.S. citizen or U.S. resident at the end of the year; and

- Spouse joins the taxpayer in making the election.

Spouses who were both NRAs at the beginning of the year and U.S. residents at the end of the year may make the election.

Individual who is single at the end of the year may not make the election.

59


Electing U.S. Resident Alien Status (§6013(h))

Effect of §6013(h) Election

- Taxpayer and spouse are both treated as U.S. residents for the entire tax year.

• Note: Sec. 6013(h) has no effect on the couple’s U.S. status in any year subsequent to the year of the election.

- Both spouses are taxed on their worldwide income.

- Spouses must file a joint return for the year of the election.

- Neither spouse may make the election for any later year, even if they separate, divorce, or remarry.

- Special instructions and restrictions for dual-status taxpayers do not apply to the taxpayer.

See Appendix for procedures for making a §6013(h) election.

- Election can be made on an amended return.

60


COMPLETING THE FORM

1040NR


Overall Structure of Form 1040NR

Form 1040NR is designed for NRA to report ECI and FDAP on which insufficient tax was withheld.

- ECI is reported on pages 1 and 2.

- FDAP taxable under §871(a)(1) and U.S. source capital gains taxable under §871(a)(2), and the tax calculated thereon, are reported on Schedule NEC on page 4. The tax is then carried to line 52 on page 2

Itemized deductions are reported on Schedule A and carried to line 37 on page 2 of Form 1040NR.

Tax on ECI, net of itemized deductions, is computed on page 2 of Form 1040NR.

Credits against tax, including credits for taxes withheld at source and estimated taxes, are shown on page 2.

Any net tax due or tax overpayment is shown at the bottom of page 2.

Page 5 asks a number of questions.

62


Community Income

Community income is treated in accordance with the applicable

community property laws with the following exceptions:

- For earned income other than income from a trade or business

or partnership distributive share income, the income is reported

by the spouse whose services earned the income on his/her

separate return

- For trade or business income other than partnership distributive

share income, income is reported by the spouse carrying on the

trade or business on that spouse’s return.

- For partnership distributive share income (loss) , income or loss

is reported on the return of the spouse who is the partner.

- For income derived from the separate property of one spouse

that is not earned income, trade or business income, or

partnership distributive share income, the income is reported on

the return of the spouse with the separate property.

63


Tax Year

Alien’s tax year is the calendar year unless the alien has

previously established a fiscal year.

Alien’s fiscal year must end on the last day of a month.

Alien who has established a fiscal year in a foreign country

prior to becoming subject to U.S. income tax may adopt the

calendar year as his/her taxable year for U.S. tax purposes

without requesting a change in accounting period.

If an alien who has previously established a fiscal year

becomes a U.S. resident during a calendar year, the alien will

be considered a U.S. resident during any part of the alien’s

fiscal year that falls within that calendar year.

See Reg. §301.7701(b)-6(b) for examples.

64


Identifying Number

Alien is required to enter either SSN or ITIN on

page 1 of Form 1040NR.

Fiduciary enters estate or trust’s EIN on page 1 of

Form 1040NR.

65


Filing Status

Married NRAs are generally taxed at the married filing

separate tax rates.

- Special rules exist for residents of Canada, Mexico. South

Korea, or married U.S. nationals.

Taxpayer who is married at the end of the year is

considered married for the entire tax year.

Taxpayer who is single, divorced, or legally separated is

considered single for the entire tax year.

If the taxpayer’s spouse died during the tax year, the

taxpayer is considered married to that spouse for the

entire tax year unless the spouse remarried before the

end of the tax year.

66


Filing Status – cont.

Married taxpayer who lives apart from his/her spouse, and

who is a resident of Canada, Mexico, or South Korea, or is a

U.S. national, may file as single if they meet the following

requirements:

- Taxpayer files a return separate from his/her spouse;

- Taxpayer paid more than half the cost to maintain his/her home

during the year;

- Taxpayer lived apart from his/her spouse during the last 6

months of the year;

- Taxpayer’s home was the main home for a child, stepchild, or

foster child for more than half of the year; and

- Taxpayer can claim a dependency exemption for the child, or the

child’s other parent claims the dependency exemption under the

rules for children of divorced or separated par Canada, Mexico.

South Korea, or married U.S. nationals.

67



Married residents of Canada or Mexico or married

U.S. nationals who meet the five requirements

should check box 1 on page 1 of Form 1040NR.

Married residents of South Korea who meet the five

requirements should check box 2 on page 1 of

Form 1040NR.

68



Qualifying widow(er) with qualifying child

- Taxpayer may check box 4 on page 1 if he/she meets all of the following requirements:

• Taxpayer was a resident of Canada, Mexico, South Korea, or a U.S. national;

• Taxpayer had not remarried by the end of the current tax year and taxpayer’s spouse died in one of the two preceding years;

• Taxpayer has a child or stepchild (not including a foster child) whom taxpayer can claim as a dependent;

• Child lived in the taxpayer’s home for the entire year;

• Taxpayer paid > one-half cost of maintaining the home;

• Taxpayer was U.S. citizen or resident in year spouse died; and

• Taxpayer could have filed a joint return in year spouse died, even if taxpayer did not do so.

69


Exemptions

NRA may generally claim personal exemption for him- or herself.

Residents of India who were students or business apprentices may be able to claim exemptions for their spouse and dependents.

Married residents of Canada, Mexico, or South Korea, or married U.S. nationals may claim an exemption for their spouse only if spouse had no gross income and cannot be claimed as a dependent on another U.S. taxpayer’s return.

Married resident of South Korea may not claim exemption for his/her spouse if spouse did not live with taxpayer in the U.S. at any time during the year.

Resident of Canada or Mexico or a U.S. national may claim an exemption for a child or other dependent on the same terms as a U.S. citizen.

Resident of South Korea may only claim an exemption for child who lived with taxpayer in the U.S. at some time during the year.

70


Income Effectively Connected With a U.S.

Trade or Business (“ECI”)

ECI, after allowable deductions, is taxed at graduated rates.

Types of ECI

- Personal services

• See Appendix for the following exemptions:

- Certain compensation for services provided in the U.S. for a foreign employer;

- Certain compensation for services performed as a regular crew member of a foreign vessel engaged in transportation between the U.S. and a foreign country or U.S. possession;

- Certain compensation received from a foreign employer by nonresident students or exchange visitors present in the U.S. under an “F”, “J”, “M”, or “Q” visa;

- Certain income received under a qualified trust or from a qualified trust exempt from U.S. tax;

• Taxable scholarship or fellowship grants received by a student or trainee temporarily present in the U.S. under an “F”, “J”, “M”, or “Q” visa.

• Distributive share of partnership income attributable to U.S. trade or business

• Distributions of DNI from an estate or trust engaged in a U.S. trade or business

71




Types of ECI – cont.

- A taxpayer who trades in stocks, securities, and commodities may or may not be engaged in a trade or business.

- Investment income may or may not be effectively connected with a U.S. trade or business.

• FDAP

• Gains (some of which are considered capital gains) from the sale or exchange of:

- Timber, coal, or domestic iron ore with a retained economic interest;

- Patents, copyrights, and similar property on which taxpayer receives contingent payments after October 4, 1966;

- Patents transferred before October 5, 1966; and

- OID obligations.

• Capital gains (and losses)

72




Tests to determine ECI

- Asset-use test

- Business activities test

Transportation income

Special rules exist for interests in U.S. real property

73


Itemized Deductions – Schedule A

NRAs may generally not claim the standard deduction.

- Exception: Students and business apprentices who are eligible for the benefits of Article 21(2) of the U.S.-India Income Tax Treaty can claim the standard deduction if they do not itemize.

Most deductions are allowed only to the extent they are allocated and apportioned to ECI, including:

- State and local income taxes;

- Job expenses and certain other miscellaneous itemized deductions subject to the 2% of AGI limitation;

- Other miscellaneous deductions, such as:

• Casualty and theft losses of income-producing property;

• Losses from other activities from Schedule K-1 (Form 1065-B), box 2;

• Deduction for repayment of amounts under claim of right > $,3,000;

• Certain unrecovered investment in a pension; and

• Impairment-related work expenses of a disabled person.

75


Itemized Deductions – Schedule A – cont.

Expenses that are allowed even if they do not relate

to ECI

- Charitable donations

- Casualty and theft losses

• Property must be located in the U.S. at the time of

casualty or theft.

76


Tax Liability (Before Credits and Payments)

Income tax computed on ECI

- Regular tax

- Additional taxes, if applicable

• Form 8814, Parent’s Election to Report Child’s Interest and Dividends

• Form 4972, Tax on Lump-Sum Distributions

- Alternative minimum tax, Form 6251

Other taxes

- Tax on income not effectively connected with a U.S. trade or business from Schedule NEC

- Unreported social security and Medicare taxes from Form 4137 and Form 8919

- Additional tax on IRAs, other retirement plans, etc.

- Transportation tax

- Household employment taxes from Schedule H (Form 1040)

77


Tax Credits

Credits are only allowed against ECI.

Some of the credits the NRA may be able to claim include:

- Foreign tax credit

- Credit for child and dependent care expenses

- Retirement savings contribution credit

- Child tax credit

- Mortgage interest credit (Form 8936)

- Qualified adoption expenses (Form 8939)

- Residential energy credits (Form 5695)

- General business credits (Form 3800)

- Credit for prior year minimum tax (Form 8801)

NRA may not claim:

- Earned income tax credit

- Credit for the elderly or disabled

- Education credits

78


Noneffectively Connected Income (NEC)

Fixed or determinable annual periodic income (“FDAP”)

- Dividends

- Interest (other than OID)

- Rents

- Premiums

- Annuities

- Salaries

- Wages

- Other compensation

- Royalties

- OID from the sale, exchange, or payment on a bond or other debt instrument issued at a discount after March 31, 1972

- Certain gross proceeds from gambling winnings in the U.S.

- Eighty-five percent of U.S. social security and tier 1 railroad retirement benefits, unless exempted by treaty

79


Noneffectively Connected Income (NEC) –

cont.

Capital gains and losses from the sale of property

not effectively connected with a U.S. trade or

business

- Note: Gains and losses from the sale of a U.S. real

property interest are treated as ECI and should be

reported on Schedule D, Form 4797, or both.

Taxed at flat 30-percent rate, unless reduced by

treaty or statute.

80


NEW IRC §1411, MEDICARE

SURTAX ON NET INVESTMENT

INCOME


New IRC §1411, Medicare Surtax on Net

Investment Income

Background Sec. 1411(a) imposes a 3.8% tax on the lesser of an

individual’s:

- Net investment income, or

- The excess (if any) of –

• Modified adjusted gross income (MAGI) over

• A threshold amount.

Threshold amount

- $250,000 for taxpayers filing a joint return or surviving spouses

- $125,000 for married taxpayers filing separately

- $200,000 for other taxpayers

82



Investment Income – cont.

Background – cont.

For estates and trusts, §1411(a)(2) imposes a 3.8%

tax on the lesser of:

- Undistributed net investment income, or

- The excess (if any) of –

• Adjusted gross income, over

• The dollar amount at which the highest tax bracket in

which §1(e) begins for the year.

83



Investment Income – cont.

Background – cont. Sec. 1411(c) defines “net investment income” as the excess (if any) of:

- The sum of –

• Gross income from interest, dividends, annuities, royalties, and rents, other than such income which is derived in the ordinary course of a trade or business described in §1411(c)(2),

• Other gross income derived from a trade or business described in §1411(c)(2), and

• Net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business not described in §1411(c)(2), over

- The deductions allowed by Subtitle A of the Internal Revenue Code that are properly allocable to such gross income or net gain.

A trade or business is described in §1411(c)(2) if the trade or business is:

- A passive activity with respect to the taxpayer, or

- A trade or business of trading in financial instruments or commodities.

Sec. 1411(e) provides that §1411 does not apply to a nonresident alien.

84


Proposed §1411 Regulations (REG-130507-

11, December 5, 2012)

Prop. Reg. §1.1411-2(a)(2)(i) provides that in the

case of a U.S. citizen or resident who is married (as

defined in §7703) to an NRA, the spouses will be

treated as married filing separately for purposes of

§1411.

- For purposes of calculating the §1411 tax, the citizen or

resident spouse will be subject to the $125,000 threshold

for married filing separately, and the NRA will be exempt

from §1411.

- Each spouse must separately calculate his/her own net

investment income.

85



11, December 5, 2012) – cont.

Prop. Reg. §1.1411-2(a)(2)(i)(B) provides that

married taxpayers who file a Federal joint income

tax return pursuant to a §6013(g) election can also

elect to be treated as making a §6013(g) election for

purposes of §1411.

- The effect of such election is to include combined income

of the two spouses in the §1411(a)(1) calculation and

subject the income to the $250,000 threshold for married

taxpayers filing a joint return.

86




Residents of U.S. Territories An individual who is a citizen, resident, or nonresident alien of the U.S.

may qualify as a bona fide resident of a U.S. territory.

Application of §1411 to a bona fide resident of a U.S. territory depends on whether the territory has a mirror code system of taxation.

- Bona fide residents of a territory that has a mirror code system have no obligation to file a U.S. income tax return provided they report and pay tax to their respective U.S. territory.

- Result is that §1411 does not apply to bona fide residents of the U.S. territories that have a mirror code system.

- Three (out of five) territories that have a mirror code of taxation include:

• Guam

• Northern Mariana Islands

• United States Virgin Islands

- U.S. territories that do not have a mirror code system are:

• Puerto Rico

• American Samoa

87




Residents of U.S. Territories

Tax under §1411(a) is applicable to bona fide residents of

Puerto Rico and American Samoa if they have U.S. reportable

income that gives rise to both net investment income and

MAGI exceeds the reporting threshold.

Sec. 1411(a) does not apply, however, to bona fide residents

of Puerto Rico and American Samoa if they are U.S.

nonresident aliens.

- Individuals who are bona fide residents of nonmirror code

jurisdictions remain subject to Chapter 1 of Subtitle A

pursuant to §876.

88


Disclaimer

The information contained herein is general in nature and based on

authorities that are subject to change. McGladrey LLP guarantees neither the

accuracy nor completeness of any information and is not responsible for any

errors or omissions, or for results obtained by others as a result of reliance

upon such information. McGladrey LLP assumes no obligation to inform the

reader of any changes in tax laws or other factors that could affect information

contained herein. This publication does not, and is not intended to, provide

legal, tax or accounting advice, and readers should consult their tax advisors

concerning the application of tax laws to their particular situations.

Circular 230 Disclosure

This analysis is not tax advice and is not intended or written to be used, and

cannot be used, for purposes of avoiding tax penalties that may be imposed

on any taxpayer.

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