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May 1994

Taxation of foreign persons on temporary assignment in the U.S. (Federal Taxation)

by Lichtig, Richard

    Abstract- Foreigners considered 'resident aliens' are subject to US income tax laws irrespective of whether their income is earned inside or outside the US. Foreign tax credits are available to income that is taxed both by the US and by another country to offset double taxation. Several factors can affect US tax rates for resident aliens, including their marital status, their intention to stay in the US, their acquisition of a green card, and their investments or ownership of a business in the country. Foreigners can reduce their US tax liability by taking advantage of tax deductions allowed for certain expenses, such as donations to US charities, property taxes, and investment interest expense. Their tax burdens may also be lightened with careful planning, including the timing of sales of capital assets and donation of property.

Elisabeth made business trips during the year that took her outside of New York. She was out of the state (and city) for 11 business days from July 1 through December 31.

Elisabeth has a bank account in Sweden in which she earned SEK 3,000 in the first half on 1993 and SEK 4,150 from July 1 through December 31, 1993. She also earned $300 of interest income from a bank account she opened after arriving in the U.S.

While in the U.S., she decided to sell some of her Swedish stockholdings. She bought one holding in 1990 for SEK 28,000 when the exchange rate was SEK 7 per U.S. dollar. She sold the stock in November 1993 for SEK 29,050 when the exchange rate was SEK 8.3 per dollar.

She rents an apartment in New York City during her stay in the U.S. She owns a residence in Sweden, which she has decided to keep while in the U.S. She paid SEK 40,000 of interest on her mortgage during 1993, SEK 20,080 before July 1, and SEK 19,920 after June 30.

The exchange rate in the first half of 1993 was SEK eight per dollar, the rate was SEK 8.3 per dollar in the second half of 1993.

Discussion of the Issues

Elisabeth's U.S. source salary would consist of one-half of the $60,000, or $30,000, received from July 1 through December 31. Also included in her U.S. salary would be the housing allowance received during 1993. This additional $12,000 brings her 1993 total U.S. source wages to $42,000.

There were 110 work days in the period from July 1 through December 31, 1993. The facts of the example reveal that Elisabeth is a non-resident of New York. This is true even though for Federal income tax purposes, she is deemed a "resident alien" of the U.S. The reason is that the Federal government's definition of a resident differs from that used by many state or local taxing jurisdictions, such as New York. Elisabeth's New York source income was $37,800 (or $42,000 X 99/110). This fraction represents the number of business days worked in the state/city as a percentage of total work days in the year.

All income that Elisabeth earned beginning on July 1 is taxable in the U.S. regardless of where it was earned. Income earned by a "resident alien" is taxable in the U.S. regardless of whether it is earned in the U.S. or in a foreign country. To prevent double taxation, U.S. tax on income that is taxed by another country is usually offset by foreign tax credits. It is assumed that no foreign country imposed an income tax on Elisabeth's foreign interest income. Elisabeth had taxable U.S. interest income of $800 (or the sum of SEK 4,150 divided by 8.3 and $300).

Although Elisabeth sold stock at a gain of SEK 1,050, she can deduct a tax loss on her U.S. tax return. Her cost is translated to U.S. dollars using the exchange rate in effect at the time the stock was originally bought. Similarly, the sale of stock is converted to dollars on the date it was sold. Thus, her U.S. tax basis was $4,000 (or SEK 28,000 divided by seven) and the proceeds from the sale of stock were $3,500 (or SEK 29,050 divided by 8.3). The deductible loss for U.S. tax purposes is $500.

Elisabeth is entitled to deduct mortgage interest expense though the home on which she is paying the interest is in Sweden. Interest expense amounted to $2,400 (or SEK 19,920 divided by 8.3).

A summary of Elisabeth's taxes are shown in the accompanying table.

Elisabeth incurred Social Security and Medicare taxes in addition to the above amounts. In 1993, the maximum amount of earned income (e.g. salary) subject to Social Security taxes was $57,600. A 6.2% tax rate is levied on this income. Medicare taxes of 1.45% are levied on the first $135,000 of earned income in 1993. The 1994 income limit on which Social Security taxes are imposed is $60,000. The Revenue Reconciliation Act of 1993 removed the income ceiling from the Medicare tax. In other words, beginning in 1994 the 1.45% tax will be imposed on all earned income. In the example, in 1993 Elisabeth was subject to Social Security taxes of $2,604 and Medicare taxes of $609. These taxes were withheld directly from her paycheck.

It may be possible to avoid U.S. Social Security and Medicare taxes under certain circumstances. To do so would require that Elisabeth be employed by her Swedish employer. Her U.S. employer and foreign employer would be taking advantage of the U.S./Sweden Totalization Agreement. There are many corporate-level tax issues that would need to be addressed before this becomes feasible. For this example, it is assumed that the totalization agreement was inapplicable.

Withholding can be adjusted if it is determined that the standard amounts being deducted from a paycheck are either too much or too little. Claiming additional "withholding exemptions" on a Form W-4 will reduce the taxes withheld; reducing the allowances will increase the withholding. Withholding allowances should be adjusted if residency is less than a full year. Also, if the resident alien has over $500 of tax from income that is not subject to withholding, additional withholding should be considered, or, in the alternative, paying quarterly estimated taxes.







Adjusted gross income 42,300


Interest expense (2,400)

Taxes withheld:










U.S. tax rates vary depending on a taxpayer's marital status. Marital status is determined on December 31. Taxes could be higher or lower if married or single. Each situation requires a careful review of all the facts.

Federal and state tax determinations can change if the facts change. Thus, obtaining a green card or making it your intention to remain in the U.S. can impact the U.S. tax liability.

A taxpayer's ownership of more than 50% of a business and certain other investments can have a significant impact on their U.S. tax liability. Such situations should be reviewed with a tax advisor.

Certain expenses are tax deductible in addition to those reflected in the above example. Some of the more common types include donations to U.S. charities, investment interest expense, certain moving expenses, and property taxes.

Planning can reduce taxes. For example, factors to consider include the timing of sales of capital assets, making donations of property (e.g. used clothing or furniture) before returning to one's foreign domicile, etc.

Certain taxpayers are entitled to make an election that could reduce taxes. For example, a married individual must generally file a return separate from his or her spouse in the years in which they arrive in and depart from the U.S. An election may be available that will allow using lower tax rates available on joint returns. This adds an element of complexity, but it should be explored to determine if taxes can be reduced.

Assume, in the above example, that Elisabeth's U.S. employer pays its employees twice a month (semi-monthly). Each semi-monthly pay check in the year of arrival would have looked something like the following (assuming she gave her employer properly filled out Forms W-4, IT- 2104.1, and IT-2104.2):











The example shows that Elisabeth is due a refund upon filing her 1993 tax return. As mentioned above, she could have adjusted her withholding to reduce the taxes withheld from each semi-monthly paycheck so as to have no balance or refund due when the return was filed. Such adjustments are prudent.

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