An NRA Withholding Overview for Non-Resident Aliens (An Overview)

An NRA Withholding Overview for Non-Resident Aliens (An Overview)

The NRA Withholding Rules 

The acronym NRA for international tax purposes refers to non-resident aliens. A non-resident alien is a non-US person who is for tax purposes. As a result, nonresident aliens are not taxed on their worldwide income. Rather, nonresident aliens are taxed on their US-sourced income – – which is either Effectively Connected Income (ECI) and more commonly FDAP (Fixed, Determinable, Annual, Periodic). In general, FDAP refers to passive types of income such as Interest, Dividends, Royalties, etc. Oftentimes, nonresident aliens do not pay US tax on their US-sourced income for the simple reason that they were unaware they had to pay tax in the first place. The United States is one of only a few countries that follows a worldwide income tax model. Most other countries utilize a residence-based taxation model and since NRAs are not residents of the U.S., they are usually unaware of these US tax requirements – which is why NRA withholding is important. Let’s take a brief look at the basics of the issue of NRA withholding:

Withholding on FDAP (30%) & ECI

In general, nonresident aliens are subject to US tax on US-sourced income. The withholding rate can vary, but FDAP is withheld at 30%. That means that the US company will have to determine the total income for the NRA and then withhold 30%.

As provided by the IRS:

      • Most types of U.S. source income received by a foreign person are subject to U.S. tax of 30%. A reduced rate, including exemption, may apply if an Internal Revenue Code Section provides for a lower rate, or if there is a tax treaty between the foreign person’s country of residence and the United States. The tax is generally withheld (NRA withholding) from the payment made to the foreign person.

What is Withholding Agent

A withholding agent is responsible for ensuring that the amount of withholding is proper and accurate. The withholding agent has to be careful that they properly withhold the amount of tax or else they can actually become personally liable for the tax that should have been withheld.

As provided by the IRS:

      • You are a withholding agent if you are a U.S. or foreign person that has control, receipt, custody, disposal, or payment of any item of income of a foreign person that is subject to withholding. A withholding agent may be an individual, corporation, partnership, trust, association, or any other entity, including any foreign intermediary, foreign partnership, or U.S. branch of certain foreign banks and insurance companies. You may be a withholding agent even if there is no requirement to withhold from a payment or even if another person has withheld the required amount from the payment.

      • Although several persons may be withholding agents for a single payment, the full tax is required to be withheld only once. Generally, the U.S. person who pays an amount subject to NRA withholding is the person responsible for withholding. However, other persons may be required to withhold.

      • For example, a payment made by a flow-through entity or nonqualified intermediary that knows, or has reason to know, that the full amount of NRA withholding was not done by the person from which it receives a payment is required to do the appropriate withholding since it also falls within the definition of a withholding agent. In addition, withholding must be done by any qualified intermediary in accordance with the terms of its qualified intermediary withholding agreement.

Withholding Agent Liability

      • As a withholding agent, you are personally liable for any tax required to be withheld. This liability is independent of the tax liability of the foreign person to whom the payment is made. If you fail to withhold and the foreign payee fails to satisfy its U.S. tax liability, then both you and the foreign person are liable for tax, as well as interest and any applicable penalties. The applicable tax will be collected only once. If the foreign person satisfies its U.S. tax liability, you may still be held liable for interest and penalties for your failure to withhold.

W-8 BEN/Treaty Election

Even though the general withholding rate is 30% for FDAP, that is not always the case. In some countries, the United States has entered into a tax treaty to reduce or eliminate withholding on certain types of income such as 401(k).

Taxpayers can request to have their withholding reduced or eliminated depending on which country they reside in and the continents of the treaty.

Form 1040NR

Each year, non-resident aliens may file a form 1040NR.  Here are some of the more common situations when a person has to file a Form 1040NR:

      • You were a nonresident alien engaged in a trade or business in the United States during 2021. You must file even if:

        • You have no income from a trade or business conducted in the United States,

        • You have no U.S. source income, or

        • Your income is exempt from U.S. tax under a tax treaty or any section of the Internal Revenue Code.

          • However, if you have no gross income* for 2021, do not complete the schedules for Form 1040-NR other than Schedule OI (Form 1040-NR). Instead, attach a list of the kinds of exclusions you claim and the amount of each.
        • You were a nonresident alien not engaged in a trade or business in the United States during 2021 and:

          • You received income from U.S. sources that is reportable on Schedule NEC, lines 1 through 12; and
          • Not all of the U.S. tax that you owe was withheld from that income.
        • You owe any special taxes, including any of the following.

          • Alternative minimum tax.

          • Additional tax on a qualified plan, including an individual retirement arrangement (IRA), or other tax-favored account. (If you are filing a return only because you owe this tax, you can file Form 5329 by itself.)

          • Household employment taxes. (If you are filing a return only because you owe these taxes, you can file Schedule H (Form 1040) by itself.)

          • Social security and Medicare tax on tips you did not report to your employer or on wages you received from an employer who did not withhold these taxes.

          • Recapture of first-time homebuyer credit. See the instructions for Schedule 2, line 10, later.

          • Write-in taxes or recapture taxes, including uncollected social security and Medicare or RRTA tax on tips you reported to your employer or on group-term life insurance and additional taxes on health savings accounts (HSAs). See the instructions for Schedule 2, line 13, or Schedule 2, line 17d, later.

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