How are Nonresident aliens taxed in the United States?
If you are a green card holder or meet the substantial presence test, you have US tax filing obligations similar to any U.S. citizen, regardless of where you work or live. Green Card holders and tax resident aliens are subject to tax on their worldwide income.
However, nonresident aliens are generally taxed on their U.S. source income, unless exempted.
For the period of non-residence, US nonresident aliens may be subject to tax based on the following three cases:
US-sourced income effectively connected with a trade or business in the US is taxed at graduated income tax rates.
US-sourced income NOT effectively connected with a trade or business in the U.S. is taxed at 30% or at treaty rate.
Non-US sourced income NOT effectively connected with a trade or business in the US is not taxed.
To illustrate the U.S. taxation of nonresident aliens living outside of the US, we will discuss this following example. This case study covers only a few types of income.
Assuming Jane Doe, a Canadian citizen has lived in the US from 2009 to 2014 on a work visa. She left the US on December 31, 2014. Before Jane repatriated to Canada, she owned a condo (mortgage loan paid off) that she now rents to a friendly young couple in Ohio. She also has an open US brokerage account to supplement her current Canadian employment income.
Here is her 2020 income from the US:
1099-B generates LTCG of $20,000
1099-Div generates Qualified Dividend of $2,000 - 50% of the dividend income is paid by US corporations.
Interest income $400 paid by foreign payers
Rental income - rents collected and expenses paid by a rental agency (property manager who receives commissions): Rents: $30,000, Expenses: $18,000. Net Income $12,000.
Is Jane required to file a 2019 US tax return as a nonresident alien? Yes - She is required to file a US tax return because she has taxable US source income.
How Is Jane taxed on her US source income? As a nonresident alien, how Jane is taxed depends on the type of income received. We are assuming for the sake of this case study that Jane is not engaged in a trade or business in the US.
Foreign-sourced. $400 is not taxable. The payer is a foreign corporation.
$1,000 is US source dividend and taxable at US-Canada tax treaty rate.
The $1,000 foreign source income is not taxable and not reported on form 1040NR.
Jane is an NRA: The $20,000 capital gain from the stock is not taxable and not reported on her IRS form 1040NR
All US sourced and taxable. She has two options on how to report the rental income as a nonresident alien with US source income:
General Rule: her gross rental income of $30,000 is taxed at a 15% (treaty rate)
If she elect under Internal Revenue Code section 871(d) to treat the income as effectively connected with a U.S. trade or business, then she may claim deductions attributable to the real property income and $12,000 of net income from the real property is taxed at the US graduated income tax rate.
Income from sources outside the United States that is not effectively connected with a trade or business in the United States is not taxable if you receive it while you are a nonresident alien. The income is not taxable even if you earned it while you were a resident alien or if you became a resident alien or a U.S. citizen after receiving it and before the end of the year.
All income for your period of residence and all income that is effectively connected with a trade or business in the United States for your period of non-residence, after allowable deductions, is added and taxed at the rates that apply to any US citizens and residents.
U.S. source income that is not effectively connected with a trade or business in the United States for your period of non-residence is subject to a flat 30% rate or to a lower treaty rate. You cannot take any deductions against this income.
As a Canadian citizen, she is required to report her worldwide income to the CRA. She may take any allowable foreign tax credit on her Canadian individual income tax return.
See IRS Form 1040NR instructions and the IRS publication 519 to learn more about the US tax guide for residents and nonresident aliens. IRS pub 54 for US citizens and Green card holders living abroad.