This article addresses some of the general rules of U.S. taxation that apply to foreign nationals working in the United States. The goal of this article is to provide some useful information for the tax issues related to employing foreign nationals, including identifying the relevant exceptions.
This article discusses the first major general rule of taxation of foreign-born U.S. workers. The general rule states that compensation for services in the U.S. is subject to U.S. tax, unless certain exceptions apply. Simple right? Let's examine.
Section 864(b) of the Internal Revenue Code
Under Section 864(b) of the Internal Revenue Code (IRC) and the regulations thereunder, compensation for the performance of services is U.S. source income to the extent that the income is paid for services performed while the worker is physically present in the United States. Under the general rule, the location of the payer is not relevant, nor is the currency of the payment. For example, if you are in the United States working at an IT consulting company on an H-1B "Specialty Occupation" visa, your income is taxable to the extent that income is considered U.S. source. For the IRS's description of these rules, visit the IRS website here.
Essentially, resident aliens are treated like U.S. citizens for purposes of federal income tax. Generally speaking, U.S. citizens are taxed on their worldwide income. A non-resident aliens is taxed differently - they are taxed on income that is generated from U.S. sources only. The IRS defines resident alien and non-resident alien differently than the United States Citizenship and Immigration Services ("USCIS" previously known as the INS). For the IRS rules on whether you are a considered a resident alien or non-resident alien by the IRS, visit the IRS website here.
The Commercial Traveler Rule Exception to Section 864(b)
Sections 861(a)(3) and 864(b)(1) and the regulations thereunder state the commercial traveler rule exception as a three-part test to determine when compensation is considered foreign source income. If the compensation is foreign source, and you are a non-resident alien, then the income is not subject to U.S. tax. Three conditions must be present for this exception to apply:
- The individual is temporarily in the United States for 90 days or less in the calendar year (this could happen if you come on the Visa Waiver Program ("VWP") or as a B-1 Business Visitor);
- Compensation for the U.S. services does not exceed $3,000 in the aggregate; and
- The services are performed as an employee of, or under contract with, a nonresident individual, foreign corporation or partnership, or a place of business maintained in a foreign country by a U.S. citizen or resident, or domestic corporation or partnership.
If the total pay is more than $3,000, the entire amount is U.S. source income and is subject to U.S. tax. The result is such that when the recipient of the compensation is a nonresident alien, the compensation is not subject to U.S. income taxation. Again, remember that resident aliens are taxed on their worldwide income, just like U.S. citizens.
This scenario is often applicable to B-1 Business Visitors who come to the United States to undergo some type of business training or attend a business conference or seminar at a U.S. host company for education in U.S. business methods. If the foreign national does not remain in the U.S. more than 90 days, you are not paid in excess of $3,000, and the payment is made under contract with a foreign entity, the income is not subject to U.S. tax.
IRC section 162 and the regulations thereunder provide that travel, food, and lodging reimbursed or paid on behalf of an employee who is temporarily away from his or her "tax home" are deductible business expenses. To be temporarily away from home, the employee must be on a work assignment anticipated to last a year or less. See Rev. Rul. 93-86, 1993-2, C.B. 71. The term tax home is a term of art under the Code. As per the IRS, your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. Having a "tax home" in a given location does not necessarily mean that the given location is your residence or domicile for tax purposes.
When the requirements of the accountable plan rules of Section 274 of the Code are met, the amounts are excludable from the employee’s income. See Reg. Sec. 1.62-2.
To meet the accountable plan rules, the payee must:
- Establish the business purpose and connection of the expenses;
- Substantiate the expenses claimed to the payer within a reasonable period of time; and
- Return any amounts to the payer, which are over and above the substantiated business expenses within a reasonable time.
Reimbursed business expenses, which do not meet these requirements cannot be excluded from income.
Expenses reimbursed for travel, food, and lodging paid to or on behalf of an individual by a prospective employer for expenses incurred in connection with interviews do not meet these conditions. However, the IRS has ruled that such reimbursements are not wages for employment tax purposes and, to the extent they do not exceed the expenses incurred, they are not includible in the individual’s gross income. See Rev. Rul. 63-77, 1963-1 C.B. 177.
Pursuant to section 872(b)(3) of the IRC and the regulations thereunder, compensation paid by a foreign employer is exempt from U.S. income tax if the following two conditions are met:
- The individual is a nonresident present in the United States in F, J, M or Q status; and
- The individual is paid by or on behalf of a foreign employer.
A "foreign employer" is defined as (1) a nonresident alien individual, (2) a foreign partnership or foreign corporation, or (3) a branch or place of business maintained in a foreign country by a domestic corporation, domestic partnership or U.S. citizen or resident alien. A foreign government or foreign government agency is not included in this definition.
For example, if you are present in the U.S. in one of the listed non-immigrant visa categories, F, J, M or Q status, and you receive compensation from a "foreign employer," that income will escape U.S. taxation.
IRC section 893 and the regulations thereunder provide an exemption from U.S. federal income taxes for wages or nonemployee compensation paid to any employee of a foreign government or of an international organization received by a foreign national as compensation for official services to the foreign government or international organization provided that certain conditions are met.
In the case of an employee of a foreign government:
- The services must be similar to services performed by U.S. government employees in foreign countries, and
- The foreign government must grant an equivalent exemption from tax to U.S. government employees performing similar services in the foreign country.
The exclusion for foreign government employees does not apply to services that are primarily in connection with commercial activity or that are performed for a controlled commercial entity.
Compensation received for official services to an international organization that qualifies for this special exemption under the International Organizations Immunities Act is also exempt from federal income tax.
The regulations under Section 1441 provide an exception for compensation paid to certain residents of Canada or Mexico who enter or leave the United States at frequent intervals to perform duties in transportation services or in connection with certain types of international projects relating to waterways. See Rev. Rul. 66-77, 1966-1 C.B. 242; Rev. Rul. 79-318, 1979-2 C.B. 35.
Neither the transportation exception nor the international projects exception applies to the compensation of a resident of Canada or Mexico who commutes to work in the United States from a residence in Canada or Mexico.