Taxation Advantages And Challenges For Visiting US Researchers Receiving Grants
And it came to pass in those days, that there went out a decree from Caesar Augustus, that all the world should be taxed. (Luke 2:1)
Have you ever got an immediate and short answer to a question about taxation of a foreign national? If your answer is yes, you are one of the very few lucky ones. This area of the Internal Revenue Code is very complex leaving foreign nationals to drown in an ocean of information.
United States has income tax treaties with over 60 countries. Many of them have rather generous provisions for tax exemption status for researcher as a recipient of a grant, scholarship, award or other similar payment. One of the many requirements to qualify for tax exempt status is that the research has to be conducted at a "school, college, university or other accredited institution". It means a school maintaining a regular faculty and established curriculum, and having an organized body of students in attendance. Certain treaties also include scientific research institutions, medical facilities, government institutions and public research institutions provided that they are engaged in research for public benefit.
Educational and other types of institutions, as the initial recipients of a grant from third parties or internally allocated funds, provide their departments with an opportunity to do research. They invite renowned researchers and scholars to the United States to conduct research. Many nonresident researchers with tax exempt grants are treated the same as employees of the institution that disburses funds to them (both receive Form W-2).
What these institutions may not take into account is that there are two ways to withhold from payments to individuals - federal tax withholding and wage-based tax withholding. "Withholding occurs when the payor of an amount due to a taxpayer does not pay the entire amount to the taxpayer; instead, the payor retains part of the amount payable and remits the retained amount to the government as a payment of tax for the benefit of the taxpayer (not the payor). In effect, withholding is an indirect and involuntary payment of tax (on behalf of the taxpayer) by the payor acting as a withholding agent who actually remits the tax payment (and an information return) to the IRS."
Wage-based withholding on the other hand develops out of the employer-employee relationship. The determination of whether an employer-employee relationship exists for federal tax purposes generally is made under a "common-law" test rather than prescribed by statute. Regulations provide that an employer-employee relationship generally exists if the person receiving the services has the right to control not only the result of the services, but also the means by which that result is accomplished; it is not necessary that the service recipient actually control the manner in which the services are performed, rather it is sufficient that the service recipient have a right to control.
Institutions generally lean towards a more conservative approach by withholding taxes from payments to individuals, as the IRS can impose an assessment on the institution for the taxes not withheld, as well as penalties and interest. The institutions withhold income and social security taxes and issue Form W-2 to foreign nationals. This can occur in institutions that have little practical experience with payments to foreign nationals or simply lack proper tax guidance in this matter.
The IRS may deny income tax treaty exemption for grant income if that income is reported on a W-2, rather than Form 1042-S or other non-wage base form. W-2 forms submitted by the institutions, define for the IRS those funds as compensation for personal services and the treaty benefits are denied. According to the IRS, the institution has categorized the individual as an employee not a recipient of a grant.
The IRS regulations under §117 provide little guidance on making this compensation versus fellowship grant determination, other than saying that the mere fact that the person is required to furnish periodic reports to the grantor to keep the grantor apprised of the progress of the research project is not sufficient, in and of itself, to convert a fellowship grant into compensation. The courts use a facts and circumstances test to determine the primary purpose for which the payment was made. This requires, in the words of the Tax Court, "a determination of the raison d'etre of the payment in question, that is, was it to further the education and training of the recipient or was it in reality payment for services which directly benefited the payor." Factors that the courts have used in determining whether a payment is made to further the educational pursuits of the recipient or to benefit the institution making the payment include:
This brings us back to the fact, that the Internal Revenue Service puts a lot of weight on the disbursing institution's income tax reporting of the funds.
- Whether the individual's services were directly related to the fulfillment of a contractual commitment to a specifically sponsored project.
- Whether the individual's services were subject to supervision, were geared to particular time schedules, required specific progress reports, and were valuable in enabling the college or university to fulfill its commitments
- Whether the individual was required to devote full-time to the project or work a certain number of hours a week.
- Whether the amount received by the individual was unusually large compared with the less generous amount normally awarded for fellowships
- The manner in which the institution treated the individual -- that is, whether it reported the payments as wages, whether it accorded faculty privileges to the individual, and whether it provided the person with health and other employee benefits.
The National Institute of Health (NIH) has shown that an institution can properly handle the nonresident income tax withholdings. They have disbursed funds to researchers and scholars from many of the income tax treaty countries for a number of years. During this period they developed a system of identification of employees and others. For example, amounts received from the NIH under provisions of the Visiting Fellows Program are generally treated as a grant, allowance, or award for purposes of whether an exemption is provided by treaty. In a section of the NIH training manual, Visiting Fellows must devote their time exclusively to their research training and are not to perform services for NIH. In addition, the manual said that the Fellows are free to choose their areas of research, are to receive guidance from an NIH sponsor only to ensure that there are no violations of NIH laboratory protocols, and have no specific duties to perform.
Amounts received from NIH under the Visiting Associates Program and Visiting Scientists Program are not tax exempt. In a later private letter ruling, the IRS contrasted this situation with the situation under an NIH Visiting Scientists Program, in which visiting scientists are appointed primarily to bring expertise to a particular program, are subject to temporary assignments to non-NIH duty stations to conduct NIH business, are paid at a level similar to professional NIH staff, and are entitled to employee benefits such as retirement, annual and sick leave, etc. The IRS concluded that the NIH visiting scientists were performing research services for NIH and that their income was therefore not eligible for exemption from U.S. tax as a grant, allowance, or award. NIH pays and reports grant money paid to individuals for research differently than employment income, thus relieving the burden of proof from the taxpayer and removing the decision-making process of the Internal Revenue Service from the subjective realm.
Currently, the major burden of establishing properly the type of payment and thus ensuring a correct treatment of the funds by the Internal Revenue Service ultimately lies with the individual. The institutions, which have the most information regarding the type of payment the recipient is being paid, should take care to properly categorize payments as either wages or grants. It is imperative that the institutions, at the very least, address this on an institution-wide level by providing their nonresident alien researchers or scholars with information regarding this issue as part of the welcome package.
Lastly, there are proactive steps that can be taken by the individuals involved. They should be advised to ask questions of the institution and request a determination to be done before the end of the year so that the proper forms can be submitted to the IRS. If the nonresidents know that their grant income qualifies for tax exempt treatment, they should fill out either Form 8233 or Form W-8BEN claiming treaty exemption and provide it to the institution that pays them. At that point the institution should not withhold federal income tax, unless there is a reason to believe that the nonresidents are not eligible for tax exemption. If a foreign national is not sure if he qualifies, he should engage a tax advisor familiar with nonresident income tax matters to help determine whether the funds he receives will be tax exempt. Once he is categorized as a nonresident receiving tax exempt income, the institute can than report his tax exempt income on Form 1042-S.
1Structure of the Federal Tax System of the United States by Meade Emory Professor of Law University of Washington School of Law Seattle, Washington Henry J. Lischer, Jr. Professor of Law Southern Methodist University Dallas, Texas and Anthony P. Polito Professor of Law Suffolk University Law School Boston, Massachusetts.
About The Author
Martin Levine, CPA, Partner at LBF International Tax LLC. Previously, Mr. Levine worked as Director of International Services Group with Aronson and Company responsible for international clients, merges and acquisitions, multi-state clients and the outsourcing practice. Prior to Aronson, he was Senior Vice President and Director of Tax for Kaiser Group International, Inc. that operated in over 30 foreign countries and employed over 5,000 people. Prior to joining Kaiser, Mr. Levine was Director of Tax at Comsat, after holding numerous other financial management positions during his 20 plus year tenure.
Natalie Berman, CPA, Partner at LBF International Tax LLC. Ms. Berman has been practicing accounting and tax for over 20 years. Most of her hands-on experience derives from public practice working with variety of business and individual clients with domestic and international background. Taxation of foreign nationals working in the U.S. for nonprofit and for-profit organizations, such as entrepreneurs, doctors, scientists, athletes, students etc. has always been primary focus of her professional practice.
The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.