Tax planning for a nonresident entering the U.S. tax system.

• Author: Garcia, Rolando

A previous Tax Clinic item set forth some planning options by which a person seeking to immigrate to the United States can mitigate the U.S. tax cost of doing so (see Garcia, "Tax Clinic: Tax Planning for High-Net-Worth Individuals Immigrating to the United States," 47 The Tax Adviser 257 (April 2016)). This item covers some of the key issues an immigrant faces after entering the U.S. tax system as a nonresident.

Tax reporting and filing obligations for nonresident alien individuals

Many non-U.S. citizens plan to skirt entry into the U.S. tax system as either a U.S. tax resident or U.S. domiciliary, such as by never being present in the United States for more than 121 days (see Sec. 7701(b)(3)(A)) or by claiming benefits as a resident of a foreign country under the residency tiebreaker rules of an income tax treaty (Regs. Sec. 301.7701(b)-7). There is likely great value in doing this because, unlike U.S. tax residents, who are subject to U.S. income tax on a worldwide basis, nonresident aliens are subject to U.S. income tax only on two types of U.S.-source income: fixed or determinable annual or periodical income (FDAP) (Sec. 871(a)) and effectively connected income (ECI) (Sec. 871(b)).

Examples of the former generally include dividends, certain interest, and royalties, but they do not include investment capital gains (unless they are not ECI and paid to a nonresident alien physically present in the United States for more than 183 days during the tax year (see below), bank deposit interest (Sec. 871(i)(2)), or portfolio investment interest (Sees. 871(h), 2104(c), and 2105(b)(3)). Examples of the latter include income earned from conducting a trade or business in the United States and gains and losses from the sale or exchange of U.S. real property interests (Sec. 897(a)(1)).

FDAP is taxed on a gross basis, with no deductions allowed, at a flat 30% rate unless a lower treaty rate applies (Sec. 871(a)(1)). For example, dividend income to Canadian citizens paid by U.S. corporations will be taxed at either 5% or 15%, depending on the relationship between the corporation and the shareholder. The tax is collected by having the payer of the FDAP income withhold at the source and remit the tax to the IRS. If a nonresident alien has no ECI and realizes only FDAP income upon which the tax was fully withheld at the source, the nonresident alien is not required to file a U.S. tax return. If the withholding was insufficient to cover the tax due, the...