What is a Foreigner for US Tax Purposes? IRS Forms W-8BEN + 1042-S
I have had the pleasure of helping many people new to either living or conducting business in the USA determine their tax liability to the US Treasury and have grown increasingly surprised about the confusion over who or what type of entity is considered a foreigner for US Tax purposes. Correctly making this determination is significant.
The most obvious foreigners are individuals who are not U.S. citizens, hold a green-card, or meet the 183 day substantial presence test. These people are commonly referred to as nonresident aliens. From there it gets nuanced and requires an attention to detail. Nonresident aliens also include individuals who meet the 183 day substantial presence test for the calendar year but who are also residents of a tax treaty country referred to as dual residents who elect with supporting documentation to be treated as nonresidents of the United States. Special rules also may apply to nonresident aliens who are former U.S. citizens or former long term green-card holders.
Additionally a foreigner for US tax purposes can be a corporation not organized under the laws of one of the 50 states or the District of Columbia. A branch of a foreign corporation located in the United States is a foreign person because it is not an entity separate and distinct from the foreign corporation.
A partnership not organized in the United States is a foreign person even if some, or all, of the partners are U.S. persons mostly because a partnership is considered a pass through entity in which tax related items on the IRS Form 1065 pass through to the individual's IRS Form 1040 via IRS Form K-1.
The distinction of foreign status is significant in that foreigners are subject to U.S. tax on their U.S. income derived from or connected to a U.S. trade or business only. Foreigners provide a IRS Form W-8BEN, certiﬁcate of foreign status and evidence of exemption to backup withholding. U.S. income payments that are not wage related and subject to employment tax are indeed subject to an automatic 30 % withholding tax called NRA withholding unless an exception applies and a valid withholding certiﬁcate supporting the exemption from is provided by the payee prior to payment. This is where many new US Foreigners get tripped up.
Foreigners must also report US income and taxes withheld on IRS Form 1042-S even if the payment is exempt from withholding. Taxable wage income and withholding is still reported on a IRS Form W-2.