Taxation of alien individuals by immigration status – H-1b

The Substantial Presence Test is a mechanical test based on counting a nonimmigrant alien’s days of physical presence in the United States under a 3-year “look-back” formula. For purposes of this 183-day test, any part of a day that a nonimmigrant alien is physically present in the United States is counted as a day of presence. There are exceptions to this rule where certain days of physical presence in the United States do not count, including days a nonimmigrant is an “exempt individual.” However, the rules allowing an “exempt individual” to exclude U.S. days of presence do not apply to H-1B aliens. Unless some other exception applies, an H-1B alien must count every day of physical presence in the United States for purposes of the Substantial Presence Test. Generally, an H-1B alien who spends 122 days in the United States in each year of the 3-year period will meet the Substantial Presence Test for the current calendar year and be considered a U.S. resident. For details on the 3-year look-back formula refer to Substantial Presence Test.

An H-1B alien who otherwise meets the Substantial Presence Test can nevertheless be treated as a nonresident for U.S. income tax purposes by satisfying the “closer connection” exception to the Substantial Presence Test. See Conditions for a Closer Connection to a Foreign Country.

If an H-1B alien meets the Substantial Presence Test, he or she should be aware of the rules for determining the official starting and ending date of their period of residency in the United States. For details on these rules, refer to Residency Starting and Ending Dates.

The following are two common scenarios that illustrate the determination of an H1-B alien’s U.S. tax residency status:

1. The H1-B alien arrives in the United States on or before July 2 of Year 1 and remains in the United States through December 31 of Year 1. The H1-B alien will have been present in the United States for at least 183 days, thus meeting the Substantial Presence Test for Year 1.  The H1-B alien’s residency starting date will be the date of his or her first arrival into the United States during Year 1.
    
2. The H1-B alien arrives in the United States on July 3 of Year 1 and remains in the United States through December 31 of Year 1. The H-1B alien was not present in the United States in either of the two immediately preceding calendar years. The H1-B alien will not have been present in the United States for at least 183 days during the 3-year period that includes Year 1 and the two preceding calendar years. The H-1B alien would have only been present in the United States for 182 days, thus failing to meet the Substantial Presence Test for Year 1. Although the H1-B alien is not a U.S. resident alien for Year 1, if he or she is present in the United States for at least 122 days during the succeeding calendar year (Year 2), the individual will qualify as a U.S. resident alien under the Substantial Presence Test in Year 2 and each succeeding calendar year that he or she is present in the United States for 122 days or more. The H1-B alien’s U.S. residency starting date in Year 2 will be the date of his or her first physical presence in the United States during Year 2.

For more fact scenarios illustrating the determination of an H-1B alien’s U.S. tax residency status, see Example 8 under Alien Residency Examples.

An H1-B alien who is a U.S. resident alien under the Substantial Presence Test and who is also a resident of his or her home country under that country’s internal tax laws, is known as a “dual resident taxpayer.” United States income tax treaties contain “tie-breaker rules” that apply to determine a single country of residence for purposes of applying the income tax treaty and calculating income tax liability in situations where an individual would otherwise be treated as a resident of both the United States and the other country, resulting in potential double taxation. H1-B aliens who claim treatment as residents of another country under the “tie-breaker rules” of a U.S. income tax treaty are treated as nonresident aliens for purposes of calculating their U.S. income tax liability and must file Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b). However, for purposes other than calculating their income tax liability (including for purposes of certain information reporting), H-1B aliens are treated as resident aliens under the Internal Revenue Code. For example, in determining whether a foreign corporation is a controlled foreign corporation under Section 957 of the Internal Revenue Code, an H-1B alien is still considered a U.S. resident (i.e., a U.S. person).

H-1B aliens who are residents of the United States under the “tie-breaker rules” of a U.S. income tax treaty will be treated as U.S. residents for purposes of the tax treaty and will be subject to the “saving clause” in the treaty, resulting in the unavailability of certain benefits under the applicable tax treaty. However, a tax treaty provision may have an exception to the saving clause, which allows an H-1B alien to continue to claim certain treaty benefits even after becoming a U.S. resident alien for tax purposes.

For more information, please refer to:

• Publication 901, U.S. Tax Treaties
• United States Income Tax Treaties – A to Z
• Claiming Tax Treaty Benefits

If an H1-B alien is not a U.S. resident alien under the rules described above under “Tax Residency Status,” he or she is a nonresident alien for U.S. tax purposes. The H-1B alien’s employer must withhold on the alien’s wages following the special rules in Chapter 9 of Publication 15, (Circular E), Employer’s Tax Guide. The H1-B visa holder should file a Form W-4, Employee’s Withholding Allowance Certificate, according to those same rules.

If the H1-B alien is a U.S. resident alien, the employer must withhold U.S. federal income tax on the employee’s wages in the same manner as one would withhold on wages paid to a U.S. citizen in the same situation (i.e., with the same marital status and number of exemptions). The H1-B alien should file a Form W-4.

If the H1-B alien elects to be treated as U.S. resident alien, his or her Form W-4 should have the following annotation written across the top: “Employee has elected or will elect to be treated as a U.S. resident alien under IRC 6013(g) or (h).”

Please refer to paragraph E, Withholding under Income Tax Treaties, below for more information regarding applicable treaty provisions effects on withholding. Please refer to Publication 15 for more information regarding employer withholding of U.S. federal incomes taxes on wages.

An H1-B alien who is paid wages in exchange for personal services performed within the United States is liable for U.S. Social Security and Medicare taxes on such wages, regardless of whether he or she is a U.S. resident alien or nonresident alien, unless he or she is engaged in a type of employment that under U.S. law is not subject to U.S. Social Security and Medicare taxes. Please refer to Publication 15 for more information.

However, if an H-1B alien is from a country with which the United States has entered into  a Totalization Agreement, he or she may claim an exemption from U.S. Social Security taxes and Medicare taxes by securing a Certificate of Coverage from the social security agency of his or her home country and presenting such Certificate of Coverage to his or her employer in the United States, according to the procedures set forth in Revenue Procedures 80-56, 84-54, and Revenue Ruling 92-9. An alternate procedure is provided in these revenue procedures for an alien who is unable to secure a Certificate of Coverage from his or her home country. For more information, see Social Security/Medicare and Self-Employment Tax Liability of Foreign Students, Scholars, Teachers, Researchers, and Trainees.

The wages paid to an H-1B alien in exchange for personal services performed within the United States are subject to U.S. federal unemployment tax (FUTA tax), regardless of whether the employee is a U.S. resident or nonresident alien, unless he or she is engaged in a type of employment which under U.S. law is not subject to FUTA tax. FUTA tax is paid by the employer and is not withheld from the H-1B alien’s wages.  Please refer to Publication 15, (Circular E), Employer’s Tax Guide.

Wages paid to an H-1B alien are reported on Forms 941, Employer's Quarterly Federal Tax Return, and W-2, Wage and Tax Statement, in the usual manner. However, if the H-1B alien is claiming treaty benefits with respect to wages, as a resident of a country with which the United States has an income tax treaty in force, such wages are reported on Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding.

If the H-1B alien is a nonresident alien, payments other than wages, such as interest, dividends, rents, royalties, or non-employee compensation are subject to gross basis withholding of U.S. federal income tax at the rate of 30%, unless he or she is eligible for a lower rate of tax under an income tax treaty. Such payments are reportable to the IRS on Forms 1042 and 1042-S.

If the H-1B alien is a U.S. resident alien, payments other than wages, such as interest, dividends, rents, royalties, and non-employee compensation are not subject to withholding of U.S. federal income tax. However, backup withholding at the rate of 28% must be applied to the payment(s) if the H-1B alien failed to report his or her U.S. Taxpayer Identification Number (TIN) to the payor of the income. A TIN for an H-1B alien is a U.S. Social Security Number (SSN) or an Individual Taxpayer Identification Number (ITIN). Such payments are reportable to the IRS on Form 1099-MISC, Miscellaneous Income, and on Form 945, Annual Return of Withheld Federal Income Tax, if backup withholding applies.

If the H-1B alien is treated for U.S. income tax purposes as a resident of a country with which the United States has an income tax treaty, he or she may benefit from a reduced rate of U.S. federal income tax on certain types of U.S. source income. For treaty benefits involving personal services income, the H-1B alien should submit a signed Form 8233, Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual, to the payor of the income. For treaty exemptions involving types of income other than personal services income, the H-1B alien should submit a Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, to the payor of the income. Such income is reported to the IRS on Forms 1042 and 1042-S by the payor of the income after the end of the year.

Note: H-1B aliens who do not timely submit the Form 8233 and/or Form W-8BEN to claim treaty benefits for purposes of an exemption or reduced rate of withholding from the payor of income may still claim the treaty benefits when filing their individual U.S. income tax return. Please refer to the Form 1040NR, Schedule OI, Instructions for more details.

For more information, please refer to:

• Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities
• Instructions for W-4
• Notice 1392, Supplemental Form W-4 Instructions for Nonresident Aliens PDF

H-1B aliens who are nonresident aliens on the last day of the taxable year generally must report their U.S.-source fixed, determinable, annual, or periodical (FDAP) income (e.g., compensation earned from working in the United States) and income effectively connected with a U.S. trade or business (ECI) on Form 1040-NR, U.S. Nonresident Alien Income Tax Return. For details on these rules, refer to Taxation of Nonresident Aliens.

If claiming treaty benefits, H-1B aliens must report both the income and the treaty benefit on Form 1040-NR, with Form 8833 (if required). Please refer to Claiming Tax Treaty Benefits.

H-1B aliens who are U.S. resident aliens for the entire taxable year must report their entire worldwide income on Form 1040, U.S. Individual Income Tax Return, in the same manner as if they were U.S. citizens. If they also paid foreign income tax on foreign-source income, they may be eligible for foreign tax credits.

For more information, please refer to:

• Taxation of Resident Aliens
• Publication 519, U.S. Tax Guide for Aliens
• Publication 514, Foreign Tax Credit for Individuals

A dual-status alien is an individual who changes residency status during the tax year from nonresident alien to resident alien or resident alien to nonresident alien. H-1B aliens who are “dual-status aliens” must file a special income tax return. For more information, refer to Taxation of Dual-Status Aliens.

A dual status H-1B alien married on the last day of the taxable year to a U.S. citizen or to a resident alien may elect with his or her spouse to file a joint Form 1040as if the H-1B visa holder was a U.S. resident alien for the entire tax year. For more information, refer to Nonresident Spouse Treated as a Resident. If they also paid foreign income tax on foreign-source income, they may be eligible for foreign tax credits (refer to Publication 514, Foreign Tax Credit for Individuals).