US Tax Filing Requirement Imposed on Nonresidents
Recently the friend of a client posed the question whether a US non-resident alien has to file a US tax return based on interest earned on an account in the US? To understand this tax filing requirement, it is first necessary to distinguish between resident and non-resident alien status.
A resident alien is someone who meets the green card or substantial presence tests. A green card holder is anyone who took no steps to revoke the card even though he or she is treated as a resident of a foreign country under a tax treaty. So according to this example, a non-resident alien can be treated as a resident alien for US tax purposes. The substantial presence test applies to any foreign person who a) was physically present in the United States for at least 31 days during the calendar year, and b) 183 days during the previous three calendar years (2008, 2007 and 2006). This latter criterion may be waived if the foreign person establishes that during 2008 he or she had a tax home in a foreign country and therefore had a closer connection to the foreign country of residence. It is possible while qualifying for substantial presence test in a tax year to be considered both a resident and non-resident alien.
Having established residency status, a non-resident alien may be obliged to file a US tax return on US source income. If the income is effectively connected with a US trade or business, then it is taxed at ordinary income tax rates and reported on line 9a of Form 1040NR (see www.irs.gov, forms and publications). Otherwise it is reported on line 76b and taxed at 30% unless superseded by tax treaty rate. Generally such income is reported by payers on Form 1042-S. When the withholding rate is correctly applied and no other US source income has been received, a non-resident alien is not obliged to file Form 1040NR.
1040NR filing is required of non-resident aliens where they have a trade or business in the United States, income is exempt from US taxation under a tax treaty, a deceased person or estate/trust is represented, or withholding amounts are incorrect. Resident aliens may file Form 1040, and is taxed the same as a US citizen.
US source interest income includes interest on bonds, notes or other interest-bearing obligations, interest paid by an entity engaged in a US trade or business, original issue discount, or government-source interest. Excludable interest income includes income not effectively connected with a US trade or business if from deposits with persons in the banking business; accounts with mutual savings banks, cooperative banks, credit unions, domestic building and loan associations, and other savings institutions chartered as savings and loan; and amounts held by an insurance company.
Generally speaking, if the income was derived from the conduct of a US business activity, then it is effectively connected.