VI. EMPLOYEE OR INDEPENDENT CONTRACTOR?
IRS Publication 15-A, Employer's Supplemental Tax Guide contains useful information
to use in making a determination of whether the worker is an employee or an
independent contractor.
If you would like the IRS to determine whether a worker is an employee, file
Form SS-8, Determination of Employee Work Status for Purpose of Federal Employment
Taxes and Income Tax Withholding, with the IRS. If you classify an employee
as an independent contractor and you had no reasonable basis for doing so, you
can be held liable for employment taxes for that worker. (Also refer to
Sec. 3402(e) Internal Revenue Code and Rev. Ruling
87-41)
VII. INCOME SOURCING RULES
Once it is determined that a payment is made to a nonresident alien, the source
of the payment must be considered. Each type of payment (e.g., scholarship,
wages, royalties) is subject to different sourcing rules. If it is determined
that a payment is U.S. source the payment may not be subject to federal withholding
tax if the income is exempt or excluded under an income tax treaty or a provision
in the Internal Revenue Code.
A. Personal Service Income
Compensation for personal services (dependent or independent) performed in the
United States, is considered U.S. source, (refer to
Sec. 861(a)(3)). The place where the services
are performed determines the sources of the income, regardless of where the
contract was made, the place of payment, or the residence of the payer. If the
compensation is for personal services performed partly in the U.S. and partly
outside the U.S., Treasury Regulation Sec.
1.861-4(b) requires an allocation be made of income for services performed
in the U.S. Usually this allocation is on a time basis. U.S. source income is
the amount that results from multiplying the total amount of income by the following
fraction:
Number of days services are performed in the U.S.
Total number of days of service for which the income is paid
Generally, 240 is the total number of business days that the IRS allows for
this computation. If employees actually work more than 240 days in a year, a
higher number for the total number of business days may be used. However, the
employee should keep records indicating the number of and the location for the
days actually worked to support the claim. Also, refer to Internal Revenue Publication
515.
B. U.S. Citizens and Resident Aliens Working Abroad
U.S. citizens and resident aliens are taxed by the United States on their worldwide
income. Therefore, such individuals who are working in a foreign country could
be taxed twice, once by the foreign government where they are posted and once
by the U.S. government.
Chapter 24 of the Internal Revenue Code,
Collection of Income Tax at Source
on Wages, SUBCHAPTER A--Withholding From Wages sections 3401(a)(8)(A)(I)
and
911 of the Internal Revenue Code provides
relief from this heavy tax burden by allowing taxpayers to exclude from their
gross income up to $70,000 of foreign earned income.
A U.S. citizen or resident alien may elect the Sec. 911 exclusion provided that
the individual:
- Has established a tax home in a foreign country; and
- Is a bona fide resident of a foreign country for at least an entire
taxable year or has been physically present in a foreign country for at
least 330 days during any 12-month period.
The maximum annual exclusion is prorated on a daily basis if there is any part
of your year that you do not qualify under either test. Employees who believe
they will qualify for the exclusions for foreign earned income must complete
Form DBF-BP-5, Reduction or Exemption From Withholding and IRS
Form 673,
Statement for Claiming Benefits Provided by Section 911, of the
Internal Revenue Code. The exemption is valid for one year. This authorizes
the agency not to withhold U.S. income taxes on amounts the employee certifies
will be excluded. In practical terms, agencies do not have to withhold U.S.
income taxes on the first $70,000 in wages paid to employees for their work
overseas. For more information, see IRS Publication 54,
Tax Guide for U.S.
Citizens and Resident Aliens Abroad.
The Sec. 911 income exclusion applies to any income that is earned in any territory
under the rule of a government other than the United States. Puerto Rico, Guam,
the Northern Mariana Islands, the Virgin Islands, American Samoa, and the Antarctic
region are not considered foreign countries for Sec. 911 exclusion purposes.
Citizens and resident aliens of the U.S. working abroad for an American employer
are covered by the Federal Insurance Contributions Act. Social security taxes
must be withheld if the work they perform would be covered by FICA in the United
States.
C. Nonresident Aliens Performing Services Outside the U.S.
Under
Sec. 1441(a) of the Internal Revenue Code, compensation
paid to a nonresident alien for services performed entirely outside of the U.S.,
is considered to be foreign source income, and no U.S. tax withholding is required.
This exclusion applies to services performed as an independent contractor and
as an employee. Nonresident alien employees performing services outside the
U.S., claiming this exemption under Sec. 1441(a) must complete a
Reduction
or Exemption From Withholding Form, DBF-BP-5.
If continuously employed, the exemption does not need to be renewed.
Refer to Section XVIII.
Nonresident Alien Payment Processing Procedures
for instructions on payments to nonresident alien independent contractor foreign
source payments.
D. U.S. Citizens Working in U.S. Possessions
Section 3401 of the Internal Revenue Code also excludes from wages some remuneration
paid to U.S. citizens working in U.S. possessions. These exclusions are:
- "Sec. 3401(a)(8)(A)(ii) for services performed in a foreign country
or in a possession of the United States by such a citizen if, at the time
of the payment of such remuneration, the employer is required by the law
of any foreign country or possession of the United States to withhold income
tax upon such remuneration; or
- Sec. 3401(a)(8)(B) for services for an employer (other than the United
States or any agency thereof) performed by a citizen of the United States
within a possession of the United States (other than Puerto Rico), if it
is reasonable to believe that at least 80 percent of the remuneration to
be paid to the employee by such employer during the calendar year will be
for such services; or
- Sec. 3401(a)(8)(C) for services for an employer (other than the United
States or any agency thereof) performed by a citizen of the United States
within Puerto Rico, if it is reasonable to believe that during the entire
calendar year the employee will be a bona fide resident of Puerto Rico."
Also refer to Sec. 31.3401(a)(8)(C)-1 of the Internal Revenue Regulations.
U.S. citizens performing services within a U.S. possession claiming the exemption
under Sec. 3401 of the Internal Revenue Code must complete a
Reduction or
Exemption From Withholding Form, DBF-BP-5. To qualify for an exemption under
Sec. 3401(a)(8)(C) the employee should file a statement with the employing agency
or university, containing a declaration under the penalties of perjury that
such statement is true to the best of the employee's knowledge and belief, that
the employee has at all times during the current calendar year been a bona fide
resident of Puerto Rico and that he/she intends to remain a bona fide resident
of Puerto Rico during the entire remaining portion of such current calendar
year.
E. Citizens of U.S. Possessions
A citizen of a possession of the United States (except Puerto Rico and Guam),
who is not otherwise a citizen or resident of the United States is treated for
the purposes of withholding as if he/she were a nonresident alien individual
(Refer to Sec. 1.932-1(a) of the Internal Revenue Regulations). Certain individuals
may qualify for a possession exclusion. The following separate exclusions cover
these locations:
- American Samoa -- Bona fide residents of American Samoa may be eligible
to exclude income from sources within American Samoa, Guam, or the Commonwealth
of the Northern Mariana Islands from U.S. taxation. Residents of American
Samoa must file Form 4563, Exclusion of Income for Bona Fide Residents of
American Samoa, to claim the income exclusion.
- Guam and the Commonwealth of the Northern Mariana Islands - New exclusion
rules will apply if, and when, new implementation agreements take effect
between the U.S. and those possessions.
- Puerto Rico -- Residents of Puerto Rico are not entitled to the possession
exclusion. However, U.S. citizens who are residents of Puerto Rico for an
entire tax year generally are not subject to U.S. tax on income from Puerto
Rican sources. U.S. tax will, however, apply to income from sources outside
of Puerto Rico. Refer to Sec. 1.933-1(a) of the Internal Revenue Regulations.
- Virgin Islands -- Residents of the Virgin Islands are not entitled to
the possession exclusion. Individuals who are bona fide residents of the
Virgin Islands at the end of the tax year should file a tax return with
the Virgin Islands only. All U.S. income should be included on the return.
U.S. citizens and resident aliens who have Virgin Islands income but are
not residents of the Virgin Islands at the end of the tax year must file
identical returns with both the U.S. and the Virgin Islands. A portion of
the U.S. tax is paid to the Virgin Islands, and credited against the U.S.
tax owed. The amount of tax paid to the Virgin Islands is calculated by
multiplying the total tax on the employee's U.S. return by a decimal. This
decimal is determined by dividing the employee's adjusted gross income from
the Virgin Islands by his or her worldwide adjusted gross income. Form 8689,
Allocation of Individual Income Tax to the Virgin Islands, is used for
this computation and must be completed and attached to the employee's U.S.
income tax return.
Section 31.3401(a)-1(b)(12) of the Internal Revenue Regulations pertains to
remuneration for services performed by permanent residents of Virgin Islands.
This sections states that withholding is not required from a payment of wages
"if at the time of payment it is reasonable to believe that the employee will
be required to satisfy his/her income tax obligations with respect to such wages
under Sec. 28(a) of the Revised Organic Act of the Virgin Islands (68 Stat.
508). That section provides that all persons whose permanent residence is in
the Virgin Islands 'shall satisfy their income tax obligations under applicable
taxing statutes of the United States by paying their tax on income derived from
all sources both within and outside the Virgin Islands into the treasury of
the Virgin Islands.'
If the employee furnishes to the employer a statement in duplicate that he/she
expects to satisfy his/her income tax obligations under Sec. 28(a) of the Revised
Organic Act of the Virgin Islands with respect to all wages subsequently to
be paid to him/her by the employer during the taxable year to which the statement
relates, the employer may, in the absence of information to the contrary, rely
on such statement as establishing reasonable belief that the employee will so
satisfy his/her income tax obligations. The employee's statement shall identify
the taxable year to which it relates, and both the original and the duplicate
copy thereof shall be signed and dated by the employee.
The original of the statement shall be retained by the employer. The duplicate
copy of the statement shall be sent by the employer to the Director of International
Operations, Washington, D.C. 20225, on or before the last day of the calendar
year in which the employer receives the statement from the employee."
Permanent residents of the Virgin Islands claiming the exemption under Sec.
31.3401(a)-1(b)(12) of the Internal Revenue Regulation must complete a
Reduction
or Exemption From Withholding Form, DBF-BP-5, and file the required statement
with their employing agency/university. The employing agency/university is responsible
for retaining the original statement and mailing the duplicate copy to the IRS.
For more information, see IRS Publication 570,
Tax Guide for Individuals
With Income From U.S. Possessions.
F. Scholarship and Fellowship Grants
Scholarship and fellowship grants are sourced based upon the residence of the
payor of the grant. IRS Revenue Ruling 89-67 sets forth the "residence of the
payor" test. Under this test, if an individual studies or performs noncompensatory
research in the U.S., but receives a grant from a non-U.S. person or entity,
the payments will be "foreign source" income and not subject to U.S. tax.
If the student receives the award from a U.S. person or entity, the payment
is treated as "U.S. source" income, regardless of where the educational activities
take place. Scholarships received by a nonresident where the educational activity
takes place outside the U.S. are treated as income from sources outside the
U.S.
In determining the "residence of the payor," the sourcing conclusion is not
affected if payments are made by an "intermediary agency" acting on behalf of
the payor. Therefore, the "true grantor" of the fellowship/scholarship must
be determined - what entity maintains control of the grant (i.e., does the grantor
name the individuals who will receive the scholarship/fellowship?).
VIII. SCHOLARSHIP/FELLOWSHIP
EXCLUSIONS AND REDUCED WITHHOLDING
Nonresident alien scholarship/fellowship payments
that are determined to be U.S. source income may be exempt under an Internal
Revenue Code or may qualify for reduced withholding under Sec. 1441(b). Two
of the possible exemptions under Internal Revenue Code applicable to scholarship/fellowship
payments are:
A. Section 117 Qualified Scholarship Exclusion
The amounts you pay for a qualified scholarship to a candidate for a degree
may be excluded from the recipient's gross income. A qualified scholarship is
one granted to an individual who is a candidate for a degree at a qualified
educational institution and is excludable only to the extent that it is used
for tuition and course-related expenses (e.g., books, supplies, and equipment).
Amounts paid under a scholarship for room, board, or other incidental expenses
are includible in gross income. Also includible is the full amount of a scholarship
or fellowship received by an individual who is not a degree candidate.
"Candidate for a degree" is a student who receives a scholarship for study at
an educational institution that (1) provides an educational program that is
acceptable for full credit toward a bachelor's or higher degree, or offers a
program of training to prepare students for gainful employment in a recognized
occupation, and (2) is authorized under federal or state law to provide such
a program, and is accredited by a nationally recognized accreditation agency.
Example. A student attends a university under a fellowship program that
does not grant degrees. Although the student is not eligible to receive a degree
as a result of his/her study, the university he/she attends meets the other
two requirements. Therefore, the student is a "candidate for degree" for purposes
of section 117.
If teaching, research, or other service is required as a condition for receiving
the grant or the degree, the portion of the scholarship or grant that represents
compensation paid for the service is taxable. Also see Internal Revenue Code
Sec. 117, 3401(a)(20), Regs. Sec. 1.117-3, 4(c), and IRS Publication 520,
Scholarships and Fellowships.
Example. A student receives a qualified scholarship from a university.
In order to receive the scholarship the student must teach a class or perform
research. These services are required of all candidates for the degree. Therefore,
the scholarship payment represents payment for services rendered and the student
should be compensated as an employee of the university.
B. Mutual Security Act of 1954, As Amended
Under Sec. 1441(c)(6) no federal income tax
withholding is required for payments made to nonresident alien fellowship/scholarship
recipients engaged in any program of training in the United States under the
Mutual Security Act of 1954, as amended if the payment constitutes a "per diem
for subsistence." When maximum per diem rates are exceeded, federal income tax
withholding will be required on the excess amounts over the allowable per diem
rate. Refer to IRS Publication 1542, Per Diem Rates, to determine maximum
allowable per diem rates.
C. Section 1441(b) Reduced Withholding
Under Sec. 1441(b) of the Internal Revenue Code,
the standard 30 percent withholding on scholarship/fellowships is reduced to
14 percent. The individual receiving the scholarship/fellowship must be present
in the U.S. under an F, J, M, or Q visa.
For individuals that are candidates for degrees, the payment must be a scholarship/fellowship
as defined by Sec. 117, but includable in the individual's gross income. If
the individual is not a candidate for a degree the following additional requirements
must be met:
- 1. The grant must be for study, training, or research at an educational
organization in the U.S., and
- 2. The grantor of the scholarship/fellowship (the true grantor, not
the paying agent) must be:
- a. A tax-exempt organization operated for charitable, religious,
education, etc., purposes, or
- b. A foreign government, or
- c. A federal, state, or local government agency, or
- d. An international organization, or a binational or multinational
educational or cultural organization created or continued by the Mutual
Educational and Cultural Exchange Act of 1961 (known as the Fulbright-Hays
Act).
If the grant does not meet both (1) and (2) above, you must withhold at 30 percent
on the amount of the grant that is from U.S. sources.
Continue to Next Section
Return to Table of Contents
