Introduction to Taxation of Aliens

International Tax Attorneys Ainer & Fraker, LLP (800) 775-7612 discuss the Special Rules pertaining to the Taxation of Aliens

Resident Aliens

A resident alien’s income is generally subject to tax in the same manner as a U.S. citizen. If you are a resident alien, you must report all interest, dividends, wages, or other compensation for services, income from rental property or royalties, and other types of income on your U.S. tax return. You must report these amounts whether from sources within or outside the United States.

Nonresident Aliens

A nonresident alien is usually subject to U.S. income tax only on U.S. source income. Under limited circumstances, certain foreign source income is subject to U.S. tax.

Dual-Status Aliens

You are a dual status alien when you have been both a resident alien and a nonresident alien in the same tax year.

Source of Income

A nonresident alien (NRA) usually is subject to U.S. income tax only on U.S. source income.

Income Types

In general, all income of a nonresident alien is Fixed, Determinable, Annual, Periodical (FDAP) income. However, certain kinds of FDAP income are considered to be effectively connected with a U.S. trade or business. These two types of income are taxed in different ways.

Reporting your Income in U.S. Currency

You must express the amounts you report on your U.S. tax return in U.S. dollars. If you receive all or part of your income, or pay some or all of your expenses in foreign currency, you must translate the foreign currency into U.S. dollars.

Tax Withholding on Foreign Persons

Payments of income to foreign persons are subject to special withholding rules. In particular, foreign athletes and entertainers are subject to substantial withholding on their U.S. source gross income. This withholding can be reduced by entering into a Central Withholding Agreement with the Internal Revenue Service.

Foreign Students and Scholars

Special rules apply to the taxation of foreign students and scholars which do not apply to other kinds of aliens.

Taxpayer Identification Numbers (TIN)

Anyone (including aliens) who files a U.S. federal tax return must have a Taxpayer Identification Number (TIN). In addition, aliens who request tax treaty exemptions or other exemptions from withholding must also have a TIN.

Tax Treaties

The U.S. tax liability of aliens is determined primarily by the provisions of the U.S. Internal Revenue Code. However, the United States has entered into certain agreements known as tax treaties with several foreign countries which oftentimes override or modify the provisions of the Internal Revenue Code.

U.S. Person

IRC 7701(a)(30) and Treas.Reg. 1.1441-1(c)(2)

The term ‘United States person’ means:

  1. A citizen or resident of the United States,
  2. A partnership created or organized in the United States or under the law of the United States or of any State,
  3. A corporation created or organized in the United States or under the law of the United States or of any State,
  4. Any estate or trust other than a foreign estate or foreign trust.
    See Internal Revenue Code section 7701(a)(31) for the definition of a
    foreign estate and a foreign trust, or
  5. Any other person that is not a foreign person.

Foreign Person

Treas.Reg. 1.1441-1(c)(2)

The term “foreign person” means:

  1. A nonresident alien individual;
  2. A corporation created or organized in a foreign country or under the laws of a foreign country;
  3. A partnership created or organized in a foreign country or under the laws of a foreign country;
  4. A foreign trust;
  5. A foreign estate, or
  6. Any other person that is not a U.S. person.

See Internal Revenue Code section 7701(a)(31) for the definition of a foreign estate and a foreign trust.

Contact International Tax Attorneys Ainer & Fraker, LLP (800) 775-7612 to discuss your International Tax needs.

Taxation of Employees of Foreign Governments

International Tax Attorneys Ainer & Fraker, LLP (800) 775-7612 discuss Tax Issues Pertaining to Employees of Foreign Governments

Wages Paid to Employees of Foreign Governments

If you are an employee of a foreign government (including foreign municipalities) your wages are exempt from U.S. income tax by:

  • A provision in a tax treaty or consular convention between the United States and their country, or
  • Meeting the requirements of U.S. tax law

Employees of international organizations can only exempt their wages from U.S. income tax by meeting the requirements of U.S. tax law.

This exemption applies only to pay received for services performed for a foreign government or international organization. Other U.S. income received by persons who qualify for this exemption may be fully taxable or given favorable treatment under an applicable tax treaty provision.

Exemption Under Tax Treaty

If you are from a country that has a tax treaty with the United States, you should first look at the treaty to see if there is a provision that exempts your income. The income of U.S. citizens and resident aliens working for foreign governments usually is not exempt. However, in a few instances, the income of a U.S. citizen with dual citizenship may qualify. Often the exemption is limited to the income of persons who also are nationals of the foreign country involved.

Exemption Under Tax Treaty – Resident Aliens From France

If you are a U.S. resident receiving wages and pensions for governmental services performed for the government of France, you are allowed a credit for taxes paid to France on this income.

Exemption Under U.S. Tax Law

Employees of foreign governments who do not qualify under a tax treaty provision and employees of international organizations may qualify for exemption by meeting the following requirements of U.S. tax law:

  1. Employees of Foreign Governments
    • If you are not a U.S. citizen, or if you are a U.S. citizen but also a citizen of the Philippines, and you work for a foreign government in the United States, your foreign government salary is exempt from U.S. tax if you perform services similar to those performed by U.S. Government employees in that foreign country and that foreign government grants an equivalent exemption.
    • To qualify for the exemption under U.S. tax law, the U.S. Department of State must certify to the U.S. Department of the Treasury that the foreign government for which you perform services in the United States grants an exemption to the employees of the Government of the United States performing services in such foreign country similar to those you perform in the United States.  However, see the Aliens Who Keep Immigrant Status section below for a special rule that may affect your qualification for this exemption.

CAUTION. The exemption under U.S. tax law applies only to current employees and not to former employees. Pensions received by former employees living in this country do not qualify for exemption.

Contact International Tax Attorneys Ainer & Fraker, LLP (800) 775-7612 to discuss your International Tax needs.

Hedging a Charitable Remainder Trust with a Life Insurance Trust

So you’ve been patiently explaining all the benefits of a Charitable Remainder Trust to your clients.

You’ve demonstrated how a CRT will save them money over an outright sale and immediate payment of taxes.

You’ve successfully overcome the client’s objection that this is more than they planned on giving to charity when they die, by pointing out that they can receive more than double their original contribution (in some cases) through the lifetime payment of income.

You feel confident that you have answered all your client’s objections, when they hit you with one final question:

“What happens if I die in the first few years after contributing my assets to a CRT?  Won’t my family lose out on all the lifetime income benefits?”

Listen as Tax and Estate Attorney John Erik Fraker addresses these concerns of his client – and how the solution to this concern might involve a substantial life insurance policy.

Overcoming Client Objections – That’s More than I Planned on Giving to Charity

As a professional advisor, you will need to know how to overcome the more common objections that clients may have.

Let’s say you have been discussing the benefits of a Charitable Remainder Trust, when the client stops you and says: “That sounds great as a concept, but that’s more than I planned on giving to charity.”

Listen as Tax and Estate Attorney John Erik Fraker addresses this common objection.

10 Ways to Lawsuit-Proof Your Estate #1

FORBES Magazine online blog, The Best Revenge – by Ashlea Ebeling, has an excellent article called 10 Ways to Lawsuit Proof Your Estate that covers a lot of the advice that we at Ainer & Fraker, LLP give to our clients.

Please read the entire article by clicking on the following link: 10 Ways to Lawsuit-Proof Your Estate.

Today, we examine part 1 – Treat Siblings Equally

You can avoid estate litigation most of the time by treating people with the same degree of relationship to you equally. Three kids get one-third each. Trouble brews when you cut out kids in favor of grandchildren or favor one family line, giving more to the child who bore you more grandchildren.

Decisions get more complicated with multiple marriages. Should you treat the children from a second or third marriage the same as your son from your first marriage, putting a 40-year-old on the same footing as a 20-year-old, who isn’t yet launched?  What about stepchildren? The default rule (that’s what happens if you die without a will or the will is thrown out) treats stepchildren the same as full children.

~ Ashlea Ebeling, 10 Ways to Lawsuit Proof Your Estate

Ainer & Fraker, LLP Analysis

Estate Equalization is one of the greatest ways to promote Family Harmony in Estate Planning.

Where the Estate has mostly non-liquid assets – i.e. Real Estate or a Family Business – it becomes more challenging to treat everyone equally.

Putting all family members on a Deed or giving everyone equal shares of stock in the Family Business is generally a recipe for family infighting.

A much better solution: Use Life Insurance to Equalize the Estate or to Save the Family Business.

In this way, everyone gets what they want – either the asset or the cash.

If they don’t like what they receive, they can always offer to buy a sibling out.

Life Insurance and the Wealth Replacement Trust

In our prior posts, we discussed how there are many Uses of Life Insurance in Estate Planning, including Estate Creation; Liquidity to Pay Estate Tax; Estate Equalization; and Using Life Insurance to Save the Family Business.

Now let’s look at one of the very best ways to leverage the value of both Life Insurance and Charitable Giving:

Using Life Insurance in a Wealth Replacement Trust

Charitable Giving is one of the best ways for families to deal with Estate Tax issues, as well as to leave a positive legacy for one’s family and community.

The Charitable Remainder Trust (CRT) offers three levels of potential Tax savings: (1) Deferral of Capital Gains Tax; (2) Immediate Income Tax deduction; and (3) Estate Tax credit for amounts passing to charity at the end of the Trust.

The Charitable Lead Trust (CLT) allows a Donor to transfer property to their Children at a greatly reduced Gift Tax level, since it receives a credit for amounts going to Charity during the term of the Trust.

A Private Family Foundation or Donor Advised Fund allows Family members to direct donations to qualified recipient organizations over many years.

In addition, a Private Foundation or Donor Advised Fund can be set up to receive the Charitable Remainder at the end of the Charitable Remainder Trust, and it can also receive the annual Charitable Gift from the Charitable Lead Trust.

However, each of these techniques can have a serious drawback.

For the Charitable Remainder Trust, what happens if the Donor dies early in the CRT’s term, leaving more money to the Charity than anticipated, and depriving the family of the use of those assets?

With the Charitable Lead Trust, what happens when the family can not wait for 10, 20 or 30 years to use the money that is locked up into the CLT?

Families that are concerned about these outcomes will often use a Wealth Replacement Trust (also known as an Irrevocable Life Insurance Trust) to replace assets passing to Charity.

If the Donor of a Charitable Remainder Trust dies early, and the CRT pays more to charity than anticipated, the Wealth Replacement Trust will replace those assets with Life Insurance death benefit proceeds.

If a Charitable Lead Trust is set up for a length term of years after the Donor dies (called a Testamentary Charitable Lead Trust), the Donor can also set up a Wealth Replacement Trust with an equal amount that will pay to the beneficiaries immediately upon his passing.

That way, the Beneficiaries will have immediate use of the Life Insurance proceeds upon the Donor’s death, and also will receive the balance of the Charitable Lead Trust at the end of it’s term of years.

In both cases, Life Insurance is used in a Wealth Replacement Trust to enhance the benefits of Charitable Giving, as well as mitigating the downside of the Charitable techniques.