This article should serve as a reminder to foreign students, scholars and other foreign government employees in the USA.
Based on the F, J, Q or M visa categories, the above taxpayers are considered non- resident aliens even if they meet substantial presence test and would otherwise be considered US tax residents.
Internal Revenue Code specifically exempts US source capital gain income generated by the non-resident aliens. I am being often asked a question whether the capital gains are taxable for foreign students, scholars and other NRAs who are in “exempt” categories for the US residency purposes.
The tax law is very clear on this. A flat 30% tax applies on US source capital gain for the NRAs who are substantially present in US for more than 183 days. This 183-day rule bears no relation to the 183-day rule under the substantial presence test of IRC section 7701(b)(3).
For example, a foreign diplomat, consular officer, or other nonresident alien employee of a foreign government, or nonresident alien employee of an international organization, who is visiting the United States in A or G nonimmigrant status for a period longer than 183 days in a calendar year would be subject to the 30 percent tax on his/her U.S. source capital gains – even if he/she continues to be a nonresident alien per the “exempt individual” rules under the substantial presence test. The same rule applies to a foreign student or scholar visiting the United States in F, J, M, or Q nonimmigrant status whose presence in the United States equals or exceeds 183 days in any calendar year.
Tax professional community including CPA Global Tax & Accounting encountered issues in recent times regarding the filing of tax returns and receiving refunds for foreign students, grantees, researchers and similar foreign persons working temporarily in United States. In recent years number of tax returns filed by these taxpayers, whose US source income and tax withholding were reported on 1042-S, were either regularly audited or their refunds were delayed beyond a reasonable period of time. This was creating an undue hardship to such taxpayers. After several representations, IRS was convinced that in most cases there were no fraudulent or questionable claims and provided a reassurance that such refunds are being issued as soon as possible while IRS is working on redesigning the process in the interim.
Here is the news release issued by IRS today (2016-23):
“In response to concerns about the difficulties that some foreign students are experiencing in obtaining refunds of withholding tax reported on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, the IRS just completed a comprehensive review of the program. As a result, the IRS is taking steps to help foreign students at United States colleges and universities and other foreign taxpayers affected by this situation, including adjusting withholding and issuing refunds as appropriate.
No additional action is needed at this time by foreign students and other foreign taxpayers who filed Form 1040NR to request a refund of tax withheld on Form 1042-S.
The IRS review found several areas that are resulting in a significant number of “false positives” in our processing systems – meaning tax returns are being selected for review and validation for issues that present minimal risk of fraudulent or erroneous refunds. While some degree of false positives is inevitable in any compliance program aimed at detecting fraud and protecting revenue, our review indicated we are not achieving the proper balance in this area. Although we initially thought the issues were caused by tax software, upon a closer review these problems were minimal and easily corrected.
Steps the IRS is taking
We are taking several actions to resolve the accounts of those taxpayers who were affected by our existing verification process and to adjust the process going forward to help avoid further issues. We are working as quickly as possible to identify all the taxpayers whose refunds are being held as a result of this process. As they are identified, we will release the hold and issue the refunds (with interest, in instances where we have exceeded the 180 calendar day period for processing these refunds).
Taxpayers whose withholding credits were denied will have their withholding restored, eliminating any balance due and thus stopping the notices of levy. Also, we will not be holding any additional refunds until we have redesigned the process in place for detecting fraudulent or questionable returns and refunds. “)