The U.S. Tax Implications of the F-1 Visa
by Loma Ince and Kristi Kubat, KPMG LLP, Minneapolis
(KPMG LLP in the United States is a KPMG International member firm)
Companies and individuals are likely finding it increasingly difficult to obtain the proper working authorization for non-U.S. citizens and non-greencard holders to work in the United States. Reasons for this include the increased turn-around time to obtain the necessary work authorization, the reduced number of available special visas, or heightened scrutiny of visa applications. As a result, when confronted with an individual who is already in the United States with a visa, employers may overlook the details and requirements of the pre-existing visa and proceed on a "business as usual" basis.
Proceeding without the proper regard for an individual's proper work authorization or continued compliance with U.S. immigration rules, can have detrimental consequences for both the employer and employee. Rather than undertaking a discussion of U.S. immigration law and the different visa types, however, the focus of this article will be on the tax consequences of the F-1 visa to both the employer and employee.
The F-1 visa is granted to foreign nationals wishing to pursue a course of academic study in the United States. For meeting the requirements and criteria under an F-1 visa, individuals and their employers should refer to the law and should consult with a qualified immigration professional.
What Is the F-1 Visa and Why Is It Used?
Certain foreign nationals may enter the United States with F-1 visas to pursue academic (e.g., high school, post-doctoral) and training programs. The student may be eligible to work based on the requirements and authorizations for the F-1 visa. The compensation earned for qualified work may be taxed preferentially for federal income tax purposes.
Employers and visa holders should be knowledgeable about both immigration and tax laws in order to remain in compliance with the F-1 visa. A violation of any of the visa requirements can carry significant immigration penalties and the loss of certain preferential tax benefits.
Federal Income Tax Consequences of F-1 Visa
U.S. residents are taxed on their worldwide income while nonresidents are taxed only on income from U.S. sources. Therefore, the first step in calculating the F-1 visa holder's U.S. tax liability is to determine that individual's U.S. residency status. Numerous factors will determine when an individual becomes resident of the United States, including visa type and days physically present in the country.
As a general rule, a foreign national is a nonresident unless he or she qualifies as a U.S. resident.1 A foreign national who is a lawful permanent resident (i.e., a greencard holder) is considered a U.S. resident for income tax purposes. This test is based on the legal authority for the individual's presence in the United States.2
The substantial presence test, however, focuses solely on an individual's physical presence in the United States. Under this test, a foreign national is resident for U.S. tax purposes when he or she has been present in the United States for more than 183 days in the current and two preceding tax years (determined by a specific formula).3 Under the substantial presence test, a foreign national is not treated as being present in the United States on any day in which he or she is considered an "exempt" individual. An exempt individual includes any student temporarily present in the United States under the F-1 visa and who "substantially complies" with the visa limitations. To be in substantial compliance, the visa holder must not be engaged in activities that are prohibited under immigration laws and that could result in the loss of F-1 visa status. F-1 visa holders are not considered "in compliance" with the visa requirements merely because their visas have not been revoked.4 Thus, it is important to note that an individual performing services outside the scope of the F-1 visa may jeopardize his or her status as an "exempt individual" for residency purposes.
Assuming the F-1 visa holder complies with the visa requirements and is a nonresident under the substantial presence test rules, he or she will be taxed only on U.S. source income. Although, the F-1 visa holder would not be considered a U.S. resident, there is an income tax return filing requirement if he or she exceeds the income threshold for nonresident income tax return filings.
U.S. Income Tax Liability
As discussed, a nonresident is generally subject to U.S. tax on income from U.S. sources. This income is divided into two categories:
- Certain investment and other passive income that is not effectively connected with a U.S. trade or business (generally, investment income), and
- Income effectively connected with a U.S. trade or business, including compensation for services performed in the United States.
Each income category is taxed separately. U.S. source income that is not effectively connected with a U.S. trade or business is taxed on a gross basis at a 30-percent rate. Income effectively connected with a U.S. trade or business, less allowable deductions, is taxed at regular graduated rates applicable to U.S. citizens and residents.5
However, an exemption from tax is available for F-1 visa holders who are paid by a foreign employer. Compensation paid by or on behalf of a foreign employer (as defined in the Internal Revenue Code) to a nonresident while working in the United States under an F-1 visa is excluded from the visa holder's gross income.6
Effect of Income Tax Treaties
Under certain circumstances, the F-1 visa holder may be able to reduce his or her U.S. federal income tax liability based on a specific article of an income tax treaty. For example, consider a Chinese national student in the United States who earns less than USD 5,000 in the tax year. In general, under Article 20 (Students and Trainees) of the U.S.People's Republic of China (PRC) income tax treaty, a resident of PRC who comes to the United States for the purpose of education, training, or obtaining technical experience is exempt from U.S. tax on payments received from abroad for maintenance, education and training, and up to USD 5,000 per year of income for personal services performed in the United States. To claim the treaty benefit, the F-1 visa holder must complete Form 8233, Exemption from Withholding on Compensation for Independent (& certain Dependent) Personal Services of a Non-Resident Alien Individual. This form must be provided to the withholding agent (employer). If there is more than one employer, a form must be provided to each employer.
U.S. Federal Withholding Requirements
Generally, all compensation for services performed by a nonresident is subject to withholding if the amounts are considered wages that are effectively connected with the conduct of a trade or business within the United States.7 Wages received by nonresidents with the F-1 visa are treated as effectively connected with the conduct of a trade or business and therefore are subject to normal graduated withholding.8
As mentioned above, if compensation is paid to the F-1 visa holder by or on behalf of a foreign employer, these amounts are excluded from the visa holder's gross income and therefore are not subject to federal income tax withholding. However, if a U.S. employer pays the compensation, federal income tax withholding applies.
FICA and FUTA Withholding Requirements
Special rules also apply to nonresidents and their employers under the employment tax rules. The Federal Insurance Contributions Act (or "FICA") tax is imposed on both the employer and employee. The tax is based on the amount of wages paid to the employee. Wages generally include all compensation from employment.9 However, for FICA tax purposes, employment does not include services performed by a nonresident temporarily present in the United States under an F-1 visa, provided the services are performed to carry out the purpose for which the person was admitted.10 Therefore, if the F-1 visa holder is a nonresident, and is in compliance with the visa requirements, no FICA tax is imposed on either the employer or employee.
The Federal Unemployment Tax Act ("FUTA") is a direct tax on the employer that is also based on wages paid for employment services.11 Similar to FICA, employment for FUTA purposes does not include services performed by a nonresident who is working in the United States on an F-1 visa and who is in compliance with the terms of the visa.12 Thus, the employer is not required to pay FUTA taxes with respect to wages paid to a nonresident F-1 visa holder who is in compliance with the visa terms.
Failure to Substantially Comply with F-1 Visa Requirements
As discussed above, an individual performing services outside the scope of the F-1 visa may jeopardize his or her status as an "exempt individual" for residency purposes. While the F-1 visa holder is present in the United States and "substantially complies" with the visa requirements, days of presence are not counted towards U.S. residency under the substantial presence test. Therefore, to be taxed as a nonresident, it is critical for the F-1 visa holder to be working under the proper authorization. Similarly, failure to comply with visa requirements may jeopardize the FICA and FUTA exceptions. Therefore, it is strongly recommended that an immigration lawyer be consulted to determine if the terms and conditions of the F-1 visa are being met for employment purposes.
State Withholding Requirements
While most states follow federal rules related to taxation of individuals present in the United States on special visas, each state should be reviewed individually to determine any potential tax impact.
F-1 visa holders with work authorization have the advantage of being able to expand on their educational studies while not being subject to certain U.S. taxes. However, both the employer and the visa holder must confirm that the visa requirements are being substantially complied with to prevent undesired tax consequences.