Resident and nonresident aliens face a slightly different set of rules when filing their taxes than those who are citizens of the United States. In fact, filers who are not citizens may be exempt from declaring certain types of income, depending on their circumstances. This article examines the definition and tax treatment of these filers. (Getting ready to file? Check out The Ultimate Tax-Time Checklist.)
TUTORIAL: Personal Income Tax Guide
Who are Resident and Nonresident Aliens?
Resident aliens are non-U.S. citizens who have green cards or who have been in the country for at least 183 days over a three-year period including the current year. Nonresident aliens are those who are legally present in the U.S. but do not have green cards, such as tourists.
Taxation of Nonresident Alien Income
Nonresident aliens are only required to pay income tax on any income that is earned or otherwise realized from a U.S. source. They do not have to pay tax on any foreign-earned income. For example, someone from Germany who owns a business in Germany and another in the U.S. will only be taxed on the income from the latter source. The German business will be ignored. Investment income realized in the U.S. that is not from a U.S. source is usually taxed at the rate of 30%, unless otherwise specified by treaty. Spouses of nonresident aliens can also opt to claim them as dependents in some cases instead of filing a joint return. Nonresident aliens must also keep careful records to show the sources of all of their income so that the IRS can clearly see what should be taxed and what is exempt.
Taxation of Resident Alien Income
Unlike nonresident aliens, resident aliens are taxed on all forms of income received, whether foreign or domestic, including any payments received from a pension from a foreign government. Resident aliens may claim the foreign earned income exclusion and/or the foreign tax credit if they qualify. However, resident aliens who work for a foreign government in the U.S. may be able to claim an exemption on their wages if the U.S. has a reciprocal tax treaty with the employing government.
The Residence Test for Resident Aliens
As mentioned previously, resident aliens carry a green card or meet the residence test. This test requires that the alien taxpayer reside in the U.S. for at least 31 days during the year, and must have been in the U.S. for at least 183 days of the past three years (including the current year). However, the residence test only counts a day of residence in the U.S. as a full day of residence for the purpose of this test for the current year. A day of residence only counts as one-third of a day of residence in the previous year and one-sixth of a day in the year before. Therefore, the total number of days of residence during the previous two years must be divided by either three or six before being totaled, and this final total must equal at least 183.
Exceptions to the Residence Test
The residence test contains numerous exceptions, which are listed below. These exceptions effectively exempt a large percentage of the legal aliens in the U.S. from having to report taxable income.
- Commute from Canada/Mexico - Those who commute from Canada or Mexico to the U.S. on a regular basis cannot count commuting days as days of residence for the purpose of the residence test.
- Tax Home - Aliens who can prove that they had a tax home in another country during the year and were not in the U.S. for 183 days during the year are usually not required to pay taxes in the U.S. even if they meet the standard residence test described above. In this case, a tax home is usually considered to be either the principal place of business or the primary residence of the person in question. Those in this category are exempt from U.S. taxation, even if they have a residence within the country. Aliens who wish to claim this exemption must file Form 8840 with the IRS. (For more, see How International Tax Rates Impact Your Investments.)
- Exempt Person – Those who must temporarily reside within the U.S. for certain reasons can claim an exemption for the days spent stateside by filing Form 8843. Those who are eligible to claim this exemption include:
-Person related to a foreign government - one with diplomatic or consular status or is an employee of an international organization (or is an immediate family member of either party).
- Medical Exception – Anyone who is involuntarily detained in the U.S. due to medical reasons can claim a medical exemption. For example, a foreign tourist who suffers a heart attack while in the U.S. and is hospitalized for three months can file Form 8843 and list the days spent here for medical reasons under this exemption.
- Tax Treaty Exception – The residence test does not override any definition of residence as specified in a tax treaty. A treaty with another country may exempt you from being classified as a resident even if an alien otherwise meets the residence test. (For related information, see Taking A Look at Tax Havens.)
Dual Tax Status
Aliens who receive their green cards during the year will have to file a dual-status return, because they are considered nonresident aliens before they got their card and resident aliens afterward. Their status changes on the day that they receive the green card. Those in this category must include a statement that breaks down all income received as a resident versus a nonresident.
When Aliens Leave
Aliens who leave the U.S. for any length of time must get a certificate of compliance that states that they have paid their U.S. taxes. Otherwise, a tax return must be filed and paid at the point of departure. Those who are leaving should obtain IRS Form 1040-C to find out what they are required to report. Those listed as exempt persons above are likewise exempt from this requirement.
Aliens and U.S. citizens who leave the U.S. and relinquish their citizenship must pay expatriation tax on all of their income and assets. The taxpayer's assets are marked-to-market and assessed for taxation on the day before expatriation.
The Bottom Line
The information outlined in this article only constitutes a summary of the tax rules that apply to resident and non-resident aliens. However, these rules can be quite complex in some cases, and the rules that a given taxpayer ultimately falls under may depend on his or her specific details. For more information, consult IRS Publication 519 or consult your tax advisor. (For related reading, also take a look at 10 Most Overlooked Tax Deductions.)