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Taxmap/pubs/p515-004.htm#TXMP67f2bf63 Withholding on Specific Income

Withholding on Specific Income

Different kinds of income are subject to different withholding requirements.

Taxmap/pubs/p515-004.htm#TXMP4d6e7293 Effectively Connected Income

Effectively Connected Income

Generally, when a foreign person engages in a trade or business in the United States, all income from sources in the United States connected with the conduct of that trade or business is considered effectively connected with a U.S. business. FDAP income may or may not be effectively connected with a U.S. business. For example, effectively connected income includes rents from real property if the alien chooses to treat that income as effectively connected with a U.S. trade or business.

The factors to be considered in establishing whether FDAP income and similar amounts are effectively connected with a U.S. trade or business include:

• Whether the income is from assets used in, or held for use in, the conduct of that trade or business, or
• Whether the activities of that trade or business were a material factor in the realization of the income.

Taxmap/pubs/p515-004.htm#TXMP3ae3dfd4 Income from securities.

There is a special rule determining whether income from securities is effectively connected with the active conduct of a U.S. banking, financing, or similar business.

If the foreign person's U.S. office actively and materially participates in soliciting, negotiating, or performing other activities required to arrange the acquisition of securities, the U.S. source interest or dividend income from the securities (or gain or loss from their sale or exchange) or, for tax years beginning after October 22, 2004, income or gain economically equivalent to such amounts, is attributable to the U.S. office and is effectively connected income.

Taxmap/pubs/p515-004.htm#TXMP6041b241 Withholding exemption.

Generally, you do not need to withhold tax on income if you receive a Form W-8ECI on which a foreign payee represents that:

• The foreign payee is the beneficial owner of the income,
• The income is effectively connected with the conduct of a trade or business in the United States, and
• The income is includible in the payee's gross income.

This withholding exemption applies to income for services performed by a foreign partnership or foreign corporation (unless item (4) below applies to the corporation). The exemption does not apply, however, to:

1. Pay for personal services performed by an individual,
2. Effectively connected taxable income of a partnership that is allocable to its foreign partners (see Partnership Withholding on Effectively Connected Income, later),
3. Income from the disposition of a U.S. real property interest (see U.S. Real Property Interest, later), or
4. Payments to a foreign corporation for personal services if all of the following apply:
   1. The foreign corporation otherwise qualifies as a personal holding company for income tax purposes,
   2. The foreign corporation receives amounts under a contract for personal services of an individual whom the corporation has no right to designate, and
   3. 25% or more in value of the outstanding stock of the foreign corporation at some time during the tax year is owned, directly or indirectly, by or for an individual who has performed, is to perform or may be designated as the one to perform, the services called for under the contract.

Taxmap/pubs/p515-004.htm#TXMP68979d66 Notional principal contract income.

Payment of an amount attributable to a notional principal contract is not subject to NRA withholding regardless of whether a Form W-8ECI is provided. However, income from a notional principal contract is subject to reporting on Form 1042-S if it is effectively connected with the conduct of a trade or business in the United States. You must treat the income as effectively connected with a U.S. trade or business if you pay the income to, or to the account of, a qualified business unit (a branch) of a foreign person located in the United States, or a qualified business unit located outside the United States and you know, or have reason to know, the income is effectively connected with the conduct of a U.S. trade or business. You do not need to treat notional principal contract income as effectively connected if you receive a Form W-8BEN that represents that the income is not effectively connected with the conduct of a U.S. trade or business or if the payee provides a representation in a master agreement or in the confirmation on the particular notional principal contract transaction that the payee is a U.S. person or a non-U.S. branch of a foreign person.

Taxmap/pubs/p515-004.htm#TXMP3c0863f0 Income paid to U.S. branch of foreign bank or insurance company.

A payment to a U.S. branch of a foreign bank or a foreign insurance company that is subject to U.S. regulation by the Federal Reserve or state insurance authorities is presumed to be effectively connected with the conduct of a trade or business in the United States unless the branch provides a Form W-8BEN or Form W-8IMY for the income. If a U.S. branch of a foreign bank or insurance company receives income that the payer did not withhold upon because of the presumption that the income was effectively connected with the U.S. branch's trade or business, the U.S. branch is required to withhold on the income if it is in fact not effectively connected with the conduct of its trade or business in the United States. Withholding is required whether the payment was collected on behalf of other persons or on behalf of another branch of the same entity.

Taxmap/pubs/p515-004.htm#TXMP69091bf0 Income Not   Effectively Connected

Income Not Effectively Connected

This section discusses the specific types of income that are subject to NRA withholding. The income codes contained in this section correspond to the income codes used on Form 1042-S (discussed later), and in most cases, on Tables 1 and 2 found at the end of this publication.

You must withhold tax at the statutory rates shown in Chart C unless a reduced rate or exemption under a tax treaty applies. For U.S. source gross income that is not effectively connected with a U.S. trade or business, the rate is usually 30%. Generally, you must withhold the tax at the time you pay the income to the foreign person. See When to withhold, earlier. Taxmap/pubs/p515-004.htm#w15019L03

Chart C. Withholding Tax Rates (Note. You must withhold tax at the following rates on payments of income unless a reduced rate or exemption is authorized under a tax treaty. The President may apply higher tax rates on income paid to residents or corporations of foreign countries that impose burdensome or discriminatory taxes on U.S. persons.) Type of Income Rate Taxable part of U.S. scholarship or fellowship grant paid to holder of F J M or Q visa (see Scholarship and Fellowship Grants, later) 14% Gross investment income from interest, dividends, rents, and royalties paid to a foreign private foundation 4% Pensions - part paid for personal services (see Pensions, Annuities, and Alimony, later) Graduated rates in Circular A or Circular E Wages paid to a nonresident alien employee (see Pay for Personal Services Performed, later) Graduated rates in Circular A or Circular E Each foreign partner's share of effectively connected income of the partnership (see Partnership Withholding on Effectively Connected Income, later) 35% Distributions of effectively connected income to foreign partners by publicly traded partnerships (see Publicly Traded Partnerships, later) 35% Dispositions of U.S. real property interests (see U.S. Real Property Interest, later) 10% (or other amount) Dividends paid to Puerto Rico corporation 10% All other income subject to withholding 30%

Taxmap/pubs/p515-004.htm#TXMP34ee15af Interest

Interest

Interest from U.S. sources paid to foreign payees is subject to NRA withholding. When making a payment on an interest bearing obligation, you must withhold on the gross amount of stated interest payable on the interest payment date, even if the payment or a portion of the payment may be a return of capital rather than interest.

A substitute interest payment made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction is treated the same as the interest on the transferred security. Use Income Code 33 to report these substitute payments.

Taxmap/pubs/p515-004.htm#TXMP248ff28c Interest paid by U.S. obligors—general (Income Code 1).

With specific exceptions, such as portfolio interest, you must withhold on interest paid or credited on bonds, debentures, notes, open account indebtedness, governmental obligations, certain deferred payment arrangements (as provided in section 483 of the Internal Revenue Code) or other evidences of indebtedness of U.S. obligors. U.S. obligors include the U.S. Government or its agencies or instrumentalities, any U.S. citizen or resident, any U.S. corporation, and any U.S. partnership.

If, in a sale of a corporation's property, payment of the bonds or other obligations of the corporation is assumed by the buyer, that buyer, whether an individual, partnership, or corporation, must deduct and withhold the taxes that would be required to be withheld by the selling corporation as if there had been no sale or transfer. Also, if interest coupons are in default, the tax must be withheld on the gross amount of interest whether or not the payment is a return of capital or the payment of income.

A resident alien paying interest on a margin account maintained with a foreign brokerage firm must withhold from the interest whether the interest is paid directly or constructively.

Interest on bonds of a U.S. corporation paid to a foreign corporation not engaged in a trade or business in the United States is subject to NRA withholding even if the interest is guaranteed by a foreign corporation that made payment outside the United States.

Domestic corporations must withhold on interest credited to foreign subsidiaries or foreign parents.

Taxmap/pubs/p515-004.htm#TXMP74ab2d57 Original issue discount (Income Code 30).

Original issue discount paid on the redemption of an obligation is subject to NRA withholding. Original issue discount paid as part of the purchase price of an obligation sold or exchanged, other than in a redemption, is not subject to NRA withholding unless the purchase is part of a plan the principal purpose of which is to avoid tax and the withholding agent has actual knowledge or reason to know of the plan. Withholding is required by a person other than the issuer of an obligation (or the issuer's agent) only if the obligation is issued after December 31, 2000.

The original issue discount subject to NRA withholding is the taxable amount of original issue discount. The taxable amount is the original issue discount that accrued while the obligation was held by the foreign beneficial owner up to the time the obligation was sold or exchanged or a payment was made, reduced by any original issue discount that was previously taxed. If a payment was made, the tax due on the original issue discount may not exceed the payment reduced by the tax imposed on the portion of the payment that is qualified stated interest.

If you cannot determine the taxable amount, you must withhold on the entire amount of original issue discount accrued from the date of issue until the date of redemption (or sale or exchange, if subject to NRA withholding) determined on the basis of the most recently published Publication 1212, List of Original Issue Discount Instruments.

For more information on original issue discount, see Publication 550, Investment Income and Expenses.

Taxmap/pubs/p515-004.htm#TXMP3af68fca Reduced Rates of   Withholding on Interest

Reduced Rates of Withholding on Interest

Certain interest is subject to a reduced rate of, or exemption from, withholding.

Taxmap/pubs/p515-004.htm#TXMP5c215868 Portfolio interest.

Interest and original issue discount that qualifies as portfolio interest is not subject to NRA withholding. To qualify as portfolio interest, the interest must be otherwise subject to NRA withholding, must be paid on obligations issued after July 18, 1984, and must meet certain other requirements.

Taxmap/pubs/p515-004.htm#TXMP03534a84 Obligations not in registered form.

Interest on an obligation that is not in registered form (bearer obligation) is portfolio interest if the obligation is foreign-targeted. A bearer obligation is foreign-targeted if:

• There are arrangements to ensure that the obligation will be sold, or resold in connection with the original issue, only to a person who is not a United States person,
• Interest on the obligation is payable only outside the United States and its possessions, and
• The face of the obligation contains a statement that any United States person who holds the obligation will be subject to limits under the United States income tax laws.

Documentation is not required for interest on bearer obligations to qualify as portfolio interest. In some cases, however, you may need documentation for purposes of Form 1099 reporting and backup withholding.

Taxmap/pubs/p515-004.htm#TXMP4211a070 Obligations in registered form.

Portfolio interest includes interest paid on an obligation that is in registered form, and for which you have received documentation that the beneficial owner of the obligation is not a United States person.

If the registered obligation is not targeted to foreign markets, you must receive documentation on which you may rely to treat the payee as a foreign person that is the beneficial owner of the interest. The documentation required is a valid Form W-8BEN (a valid Form W-8EXP from an entity that completes the Form W-8EXP for other purposes is also acceptable) or, if allowable, valid documentary evidence. See Documentation, earlier.

A registered obligation is targeted to foreign markets if it is sold (or resold in connection with its original issuance) only to foreign persons or to foreign branches of U. S. financial institutions in accordance with procedures similar to those provided under section 1.163-5(c)(2)(i) of the regulations. However, the procedure that requires the obligation to be offered for sale (or resale) only outside the United States does not apply if the registered obligation is offered for sale through a public auction. Also, the procedure that requires the obligation to be delivered outside the United States does not apply if the obligation is considered registered because it may be transferred only through a book entry system and the obligation is offered for sale through a public auction. The documentation needed depends on whether the interest is paid to a financial institution, a member of a clearing organization, or to some other foreign person.

Taxmap/pubs/p515-004.htm#TXMP6d6ba3b2 Interest that does not qualify as portfolio interest.

Payments to certain persons and payments of contingent interest do not qualify as portfolio interest. You must withhold at the statutory rate on such payments unless some other exception, such as a treaty provision applies.

Taxmap/pubs/p515-004.htm#TXMP1c317cf9 Ten-percent owners.

Interest paid to a foreign person that owns 10% or more of the total combined voting power of all classes of stock of a corporation, or 10% or more of the capital or profits interest in a partnership, that issued the obligation on which the interest is paid is not portfolio interest. Generally, the constructive ownership of stock rules apply in determining if a person is a 10% shareholder of a corporation.

Taxmap/pubs/p515-004.htm#TXMP16901fcd Banks.

Except in the case of interest paid on an obligation of the United States, interest paid to a bank on an extension of credit made pursuant to a loan agreement entered into in the ordinary course of the bank's trade or business does not qualify as portfolio interest.

Taxmap/pubs/p515-004.htm#TXMP14d20e40 Controlled foreign corporations.

Interest paid to a controlled foreign corporation from a person related to the controlled foreign corporation is not portfolio interest.

Taxmap/pubs/p515-004.htm#TXMP57e31c13 Contingent interest.

Portfolio interest generally does not include contingent interest. Contingent interest is interest that is determined by reference to any of the following.

• Any receipts, sales, or other cash flow of the debtor or related person.
• Income or profits of the debtor or related person.
• Any change in value of any property of the debtor or a related person.
• Any dividend, partnership distributions, or similar payments made by the debtor or a related person.

The term "related person" is defined in section 871(h)(4)(B) of the Internal Revenue Code.

The contingent interest rule does not apply to any interest paid or accrued on any indebtedness with a fixed term that was issued:

• On or before April 7, 1993, or
• After April 7, 1993, pursuant to a written binding contract in effect on that date and at all times thereafter before that indebtedness was issued.

Taxmap/pubs/p515-004.htm#TXMP0591c1de Interest on real property mortgages (Income Code 2).

Certain treaties (see Table 1) permit a reduced rate or exemption for interest paid or credited on real property mortgages. This is interest paid on any type of debt instrument that is secured by a mortgage or deed of trust on real property located in the United States, regardless of whether the mortgagor (or grantor) is a U.S. citizen or a U.S. business entity.

Taxmap/pubs/p515-004.htm#TXMP2d5962cd Interest paid to controlling foreign corporations (Income Code 3).

A treaty may permit a reduced rate or exemption for interest paid by a domestic corporation to a controlling foreign corporation. The interest may be on any type of debt including open or unsecured accounts payable, notes, certificates, bonds, or other evidences of indebtedness.

Taxmap/pubs/p515-004.htm#TXMP029358e2 Interest paid by foreign corporations (Income Code 4).

If a foreign corporation is engaged in a U.S. trade or business, any interest paid by the foreign corporation's trade or business in the United States (branch interest) is subject to NRA withholding as if paid by a domestic corporation (without considering the "payer having income from abroad" exception). As a result, the interest paid to foreign payees is generally subject to NRA withholding. In addition, if "allocable interest" exceeds the branch interest paid, the excess interest is also subject to tax and reported on the foreign corporation's income tax return, Form 1120-F. See Instructions for Form 1120-F for more information.

If there is no treaty provision that reduces the rate of withholding on branch interest, you must withhold tax at the statutory rate of 30% on the interest paid by a foreign corporation's U.S. trade or business.

In general, payees of interest from a U.S. trade or business of a foreign corporation are entitled to reduced rates of, or exemption from, tax under a treaty in the same manner and subject to the same conditions as if they had received the interest from a domestic corporation. However, a foreign corporation that receives interest paid by a U.S. trade or business of a foreign corporation must also be a qualified resident of its country of residence to be entitled to benefits under that country's tax treaty. If the foreign corporation is a resident of a country that has entered into an income tax treaty since 1987 that contains a limitation on benefits article, the foreign corporation need only satisfy the limitation on benefits article in that treaty to qualify for a reduced rate of tax.

Alternatively, a payee may be entitled to treaty benefits under the payer's treaty if there is a provision in that treaty that applies specifically to interest paid by the payer foreign corporation. This provision may exempt all or a part of this interest. Some treaties provide for an exemption regardless of the payee's residence or citizenship, while others provide for an exemption according to the payee's status as a resident or citizen of the payer's country.

A foreign corporation that pays interest must be a qualified resident (under section 884 of the Internal Revenue Code) of its country of residence for the payer's treaty to exempt payments from tax by the foreign corporation. However, if the foreign corporation is a resident of a country that has entered into an income tax treaty since 1987 that contains a limitation on benefits article, the foreign corporation need only satisfy the limitation on benefits article in that treaty to qualify for the exemption.

Taxmap/pubs/p515-004.htm#TXMP72d96d9b Interest on deposits (Income Code 29).

Foreign persons are not subject to withholding on interest that is not connected with a U.S. trade or business if it is from:

• Deposits with persons carrying on the banking business,
• Deposits or withdrawable accounts with savings institutions chartered and supervised under federal or state law as savings and loan or similar associations, such as credit unions, if the interest is or would be deductible by the institutions, or
• Amounts left with an insurance company under an agreement to pay interest on them.

Deposits include certificates of deposit, open account time deposits, Eurodollar certificates of deposit, and other deposit arrangements.

The deposit interest exception does not require a Form W-8BEN. However, a Form W-8BEN may be required for purposes of Form 1099 reporting and backup withholding.

You may have to file Form 1042-S to report certain payments of interest on deposits.

Taxmap/pubs/p515-004.htm#TXMP79dc82ea Interest from foreign business arrangements.

In general, interest received from a resident alien individual or a domestic corporation is not subject to NRA withholding if at least 80% of the payer's gross income from all sources has been from active foreign business for the 3 tax years of the payer before the year in which the interest is paid, or for the applicable part of those 3 years. Active foreign business income is gross income which is:

• Derived from sources outside the United States, and
• Attributable to the active conduct of a trade or business in a foreign country or possession of the United States by the individual or corporation.

However, limits apply if the recipient is considered to be a related person (see section 861(c) of the Internal Revenue Code). A foreign beneficial owner does not need to provide a Form W-8 or documentary evidence for this exception. However, documentation may be required for purposes of Form 1099 reporting and backup withholding.

Taxmap/pubs/p515-004.htm#TXMP4e32b0f6 Sales of bonds between interest dates.

Amounts paid as part of the purchase price of an obligation sold or exchanged between interest payment dates is not subject to NRA withholding. This does not apply if the sale or exchange is part of a plan the principal purpose of which is to avoid tax and you have actual knowledge or reason to know of the plan. The exemption from NRA withholding applies even if you do not have any documentation from the payee. However, documentation may be required for purposes of Form 1099 reporting and backup withholding.

Taxmap/pubs/p515-004.htm#TXMP73f33e8d Short-term obligations.

Interest and original issue discount paid on an obligation that was issued at a discount and that is payable 183 days or less from the date of its original issue (without regard to the period held by the taxpayer) is not subject to NRA withholding. This exemption applies even if you do not have any documentation from the payee. However, documentation may be required for purposes of Form 1099 reporting and backup withholding.

Taxmap/pubs/p515-004.htm#TXMP4679a184 Income from U.S. Savings Bonds of residents of the Ryukyu Islands or the Trust Territory of the Pacific Islands.

Interest from a Series E, Series EE, Series H, or Series HH U.S. Savings Bond is not subject to NRA withholding if the nonresident alien individual acquired the bond while a resident of the Ryukyu Islands or the Trust Territory of the Pacific Islands.

Taxmap/pubs/p515-004.htm#TXMP08e71fd5 Dividends

Dividend

The following types of dividends paid to foreign payees are generally subject to NRA withholding.

A substitute dividend payment made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction is treated the same as a distribution on the transferred security. Use Income Code 34 to report these substitute payments.

Taxmap/pubs/p515-004.htm#TXMP08017671 Dividends paid to Puerto Rico corporation.

The tax rate on dividends paid to a corporation created or organized in, or under the law of, the Commonwealth of Puerto Rico is 10%, rather than 30%. This applies to dividends paid after October 22, 2004, if:

• At all times during the tax year less than 25% in value of the Puerto Rico corporation's stock is owned, directly or indirectly, by foreign persons;
• At least 65% of the Puerto Rico corporation's gross income is effectively connected with the conduct of a trade or business in Puerto Rico or the United States for the 3-year period ending with the close of the tax year of that corporation (or the period the corporation or any predecessor has been in existence, if less); and
• No substantial part of the income of the Puerto Rico corporation is used, directly or indirectly, to satisfy obligations to a person who is not a bona fide resident of Puerto Rico or the United States.

Taxmap/pubs/p515-004.htm#TXMP5eea5d23 Dividends paid by U.S. corporations — general (Income Code 6).

This category includes all distributions of domestic corporations (other than dividends qualifying for direct dividend rate—Income Code 7).

A corporation making a distribution with respect to its stock or any intermediary making a payment of such a distribution, is required to withhold on the entire amount of the distribution. However, a distributing corporation or intermediary may elect to not withhold on the part of the distribution that:

1. Represents a nontaxable distribution payable in stock or stock rights,
2. Represents a distribution in part or full payment in exchange for stock,
3. Is not paid out of current or accumulated earnings and profits, based on a reasonable estimate of the anticipated amount of earnings and profits for the tax year of the distribution made at a time reasonably close to the date of the distribution,
4. Represents a capital gain dividend (use Income Code 36) or an exempt interest dividend by a regulated investment company, or
5. Is subject to withholding under section 1445 of the Internal Revenue Code (withholding on dispositions of U.S. real property interests) and the distributing corporation is a U.S. real property holding corporation or a real estate investment trust (REIT).

The election is made by actually reducing the amount of withholding at the time the distribution is paid.

Taxmap/pubs/p515-004.htm#TXMP72a58242 Dividends paid by a REIT.

For tax years beginning after October 22, 2004, a distribution by a REIT is treated as a dividend and is not subject to withholding under section 1445 as a gain from the sale or exchange of a U.S. real property interest if:

• The distribution is on stock regularly traded on a securities market in the United States, and
• The shareholder did not own more than 5% of that stock at any time during the REIT's tax year.

If these requirements are not met, item (5) in the previous list applies to the distribution.

Taxmap/pubs/p515-004.htm#TXMP305bd6a0 Dividends paid by a domestic corporation (an "80/20" company).

Generally, a percentage of any dividend paid by a domestic corporation that received at least 80% of its gross income from the active conduct of a foreign business for a testing period is not subject to NRA withholding. The testing period is the 3 tax years before the year in which the dividends are declared, or shorter period if the corporation was not in existence for 3 years. The percentage is found by dividing the corporation's foreign gross income for the testing period by the corporation's total gross income for that period.

Taxmap/pubs/p515-004.htm#TXMP28ca1c20 Main business in Puerto Rico or the Virgin Islands.

Dividends paid by a domestic corporation that generally conducts its main business activities in Puerto Rico or the Virgin Islands and that has chosen the Puerto Rico economic activity credit or the possession tax credit are not subject to NRA withholding.

Taxmap/pubs/p515-004.htm#TXMP03aa0f38 Consent dividends.

If you receive a Form 972, Consent of Shareholder To Include Specific Amount in Gross Income, from a nonresident alien individual or other foreign shareholder who agrees to treat the amount as a taxable dividend, you must pay and report on Form 1042 and Form 1042-S any withholding tax you would have withheld if the dividend had been actually paid.

Taxmap/pubs/p515-004.htm#TXMP619e56a1 Dividends paid by a regulated investment company (RIC).

Subject to certain exceptions, no withholding is required on interest-related dividends and short-term capital gain dividends paid by a RIC. This applies to dividends paid for tax years of the RIC that begin after December 31, 2004.

To qualify for this treatment, the RIC must designate any part of a dividend as an interest-related dividend or a short-term capital gain dividend in a written notice mailed to the shareholder not later than 60 days after close of the RIC's tax year. The amount designated is subject to dollar limitations.

The no withholding rule does not apply to interest-related dividends:

• To the extent the dividend is attributable to interest on debt issued by the person (or a corporation or partnership of which that person is a 10% owner) who receives the dividend,
• Unless documentation is received indicating that the beneficial owner is a foreign person, or
• Paid to a person in a foreign country (or addressed to, or for the account of, persons in a foreign country) during a period specified for that country by the Commissioner.

The no withholding rule does not apply to short-term capital gain dividends paid to a nonresident alien individual present in the United States for 183 days or more during the tax year.

For more information on these dividends, see section 871(k) of the Internal Revenue Code and, for amounts paid to a foreign corporation, section 881(e).

Taxmap/pubs/p515-004.htm#TXMP2d14c9d5 Dividends qualifying for direct dividend rate (Income Code 7).

A treaty may reduce the rate of withholding on dividends from that which generally applies under the treaty if the shareholder owns a certain percentage of the voting stock of the corporation. Generally, this preferential rate applies only if the shareholder directly owns the required percentage, although some treaties permit the percentage to be met by direct or indirect ownership. The preferential rate may apply to the payment of a deemed dividend under section 304(a)(1) of the Internal Revenue Code. Under some treaties, the preferential rate for dividends qualifying for the direct dividend rate applies only if no more than a certain percentage of the paying corporation's gross income for a certain period consists of dividends and interest other than dividends and interest from subsidiaries or from the active conduct of a banking, financing, or insurance business. A foreign person claiming the direct dividend rate should complete line 10 of Form W-8BEN regarding special rates and conditions.

Taxmap/pubs/p515-004.htm#TXMP158bba7e Consent dividends.

If you receive a Form 972 from a foreign shareholder qualifying for the direct dividend rate, you must pay and report on Form 1042 and Form 1042-S any withholding tax you would have withheld if the dividend had been actually paid.

Taxmap/pubs/p515-004.htm#TXMP17bbab2f Dividends paid by foreign corporations (Income Code 8).

For payments made after December 31, 2004, dividends paid by a foreign corporation are generally not subject to NRA withholding. This exception does not require a Form W-8BEN. However, a Form W-8BEN may be required for purposes of Form 1099 reporting and backup withholding.

The payment to a foreign corporation by a foreign corporation of a deemed dividend under section 304(a)(1) of the Internal Revenue Code is subject to NRA withholding except to the extent it can be clearly determined to be from foreign sources.

Taxmap/pubs/p515-004.htm#TXMP16d690d8 Corporation subject to branch profits tax.

If a foreign corporation is subject to branch profits tax for any tax year, withholding is not required on any dividends paid by the corporation out of its earnings and profits for that tax year. Dividends may be subject to NRA withholding if they are attributable to any earnings and profits when the branch profits tax is prohibited by a tax treaty.

A foreign person may claim a treaty benefit on dividends paid by a foreign corporation to the extent the dividends are paid out of earnings and profits in a year in which the foreign corporation was not subject to the branch profits tax. However, you may apply a reduced rate of withholding under an income tax treaty only under rules similar to the rules that apply to treaty benefits claimed on branch interest paid by a foreign corporation. You should check the specific treaty provision.

Taxmap/pubs/p515-004.htm#TXMP4c08e442 Gains

Gain

You generally do not need to withhold on gains from the sale of real or personal property because it is not FDAP income. However, see U.S. Real Property Interest, later.

Taxmap/pubs/p515-004.htm#TXMP43658b0b Capital gains (Income Code 9).

You must withhold at 30%, or if applicable, a reduced treaty rate, on the gross amount of the following items:

• Gains on disposal of timber, coal, or domestic iron ore with a retained economic interest, unless an election is made to treat those gains as income effectively connected with a U.S. trade or business,
• Gains on contingent payments received from the sale or exchange after October 4, 1966, of patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other like property,
• Gains on certain transfers of all substantial rights to, or an undivided interest in, patents if the transfers were made before October 5, 1966, and
• Certain gains from the sale or exchange of original issue discount obligations issued after March 31, 1972. For more on withholding on original issue discount obligations, see Interest, earlier.

If you do not know the amount of the gain, you must withhold an amount necessary to assure that the tax withheld will not be less than 30% of the recognized gain. The amount to be withheld, however, must not be more than 30% of the amount payable because of the transaction.

Unless you have reason to believe otherwise, you may rely upon the written statement of the person entitled to the income as to the amount of gain. The Form W-8 or documentary evidence must show the beneficial owner's basis in the property giving rise to the gain.

Taxmap/pubs/p515-004.htm#TXMP086d96b1 Tax treaties.

Many tax treaties exempt certain types of gains from U.S. income tax. Be sure to carefully check the provision of the treaty that applies before allowing an exemption from withholding.

Taxmap/pubs/p515-004.htm#TXMP30377c2c Royalties

Royalties

In general, you must withhold tax on the payment of royalties from sources in the United States. However, certain types of royalties are given reduced rates or exemptions under some tax treaties. Accordingly, these different types of royalties are treated as separate categories for withholding purposes.

Taxmap/pubs/p515-004.htm#TXMP2da73da8 Industrial royalties (Income Code 10).

This category of income includes royalties for the use of, or the right to use, patents, trademarks, secret processes and formulas, goodwill, franchises, "know-how," and similar rights. It also may include rents for the use or lease of personal property. Under certain tax treaties, different rates may apply to royalties for information concerning industrial, commercial, and scientific know-how.

Taxmap/pubs/p515-004.htm#TXMP29f2dc21 Motion picture or television copyright royalties (Income Code 11).

This category refers to royalties paid for the use of motion picture and television copyrights.

Taxmap/pubs/p515-004.htm#TXMP3801fd40 Other royalties (e.g., copyright, recording, publishing) (Income Code 12).

This category refers to the royalties paid for the use of copyrights on books, periodicals, articles, etc., except motion picture and television copyrights.

Taxmap/pubs/p515-004.htm#TXMP099fe09f Real Property Income and   Natural Resources Royalties   (Income Code 13)

Real Property Income and Natural Resources Royalties (Income Code 13)

You must withhold tax on income (such as rents and royalties) from real property located in the United States and held for the production of income, unless the foreign payee elects to treat this income as effectively connected with a U.S. trade or business. If the foreign payee chooses to treat this income as effectively connected, the payee must give you Form W-8ECI (discussed earlier). This real property income includes royalties from mines, wells, or other natural deposits, as well as ordinary rents for the use of real property. For withholding that applies to the disposition of U.S. real property interests, see U.S. Real Property Interest, later.

Taxmap/pubs/p515-004.htm#TXMP7b1984e5 Pensions, Annuities, and   Alimony (Income Code 14)

Pensions, Annuities, and Alimony (Income Code 14)

The following rules apply to withholding on pensions, annuities, and alimony of foreign payees.

Taxmap/pubs/p515-004.htm#TXMP5e15daaf Pensions and annuities.

Generally, you must withhold tax on the gross amount of pensions and annuities that you pay that are from sources within the United States. This includes amounts paid under an annuity contract issued by a foreign branch of a U.S. life insurance company. However, most tax treaties provide that private pensions and annuities are exempt from withholding.

In the absence of a treaty exemption, you must withhold at the statutory rate of 30% on the entire distribution that is from sources within the United States. You may, however, apply withholding at graduated rates to the portion of a distribution that arises from the performance of services in the United States after December 31, 1986, provided you receive Form W-8ECI and can determine the portion of the distribution that constitutes income effectively connected with the conduct of a trade or business in the United States.

Employer contributions to a defined benefit plan covering more than one individual are not made for the benefit of a specific participant, but are made based on the total liabilities to all participants. All funds held under the plan are available to provide benefits to any participant. If the distribution is from such a plan, you can use the method in Revenue Procedure 2004-37 to allocate the distribution to sources in the United States. You can find Revenue Procedure 2004-37 on page 1099 of Internal Revenue Bulletin 2004-26 at www.irs.gov/pub/irs-irbs/irb04-26.pdf.

The withholding rules that apply to payments to foreign persons generally take precedence over any other withholding rules that would apply to distributions from qualified plans and other qualified retirement arrangements.

Taxmap/pubs/p515-004.htm#TXMP646ae44c No withholding.

Do not withhold tax on an annuity payment to a nonresident alien if at the time of the first payment from the plan, 90% or more of the employees eligible for benefits under the plan are citizens or residents of the United States and the payment is:

1. For the nonresident's personal services performed outside the United States, or
2. For personal services by a nonresident individual present in the United States for 90 days or less during each tax year, whose pay for those services does not exceed $3,000, and the personal services are performed for:
   1. A nonresident alien individual, foreign partnership, or foreign corporation not engaged in a trade or business in the United States, or
   2. An office or place of business of a U.S. resident or citizen which is maintained outside the United States.

If the payment otherwise qualifies under these rules, but less than 90% of the employees eligible for benefits are citizens or residents of the United States, you still need not withhold tax on the payment if:

• The recipient is a resident of a country that gives a substantially equal exclusion to U.S. citizens and residents, or
• The recipient is a resident of a beneficiary developing country under the Trade Act of 1974.

The foreign person entitled to the payments must provide you with a Form W-8BEN that contains the TIN of the foreign person.

Taxmap/pubs/p515-004.htm#TXMP3f380e4e Alimony payments.

Generally, alimony payments made by U.S. residents to nonresident aliens are taxable and subject to NRA withholding whether the recipients are residing abroad or are temporarily present in the United States.

Many tax treaties, however, provide for an exemption from withholding for alimony payments. These treaties are shown in Table 1, by a footnote reference under Income Code number 14.

Alimony payments made to a nonresident alien by a U.S. ancillary administrator of a nonresident alien estate are from foreign sources and are not subject to withholding.

Taxmap/pubs/p515-004.htm#TXMP64daf2c3 Scholarships and Fellowship   Grants (Income Code 15)

Scholarship and Fellowship Grant

A scholarship or fellowship grant is an amount given to an individual for study, training, or research, and which does not constitute compensation for personal services. Whether a fellowship grant from U.S. sources is subject to NRA withholding depends on the nature of the payments and whether the recipient is a candidate for a degree. See Scholarships, fellowships, and grants under Source of Income earlier.

Taxmap/pubs/p515-004.htm#TXMP04f92fdb Candidate for a degree.

Do not withhold on a qualified scholarship from U.S. sources granted and paid to a candidate for a degree. A qualified scholarship means any amount paid to an individual as a scholarship or fellowship grant to the extent that, in accordance with the conditions of the grant, the amount is to be used for the following expenses:

• Tuition and fees required for enrollment or attendance at an educational organization, and
• Fees, books, supplies, and equipment required for courses of instruction at the educational organization.

The payment of a qualified scholarship to a nonresident alien is not reportable and is not subject to NRA withholding. However, the portion of a scholarship or fellowship paid to a nonresident alien which does not constitute a qualified scholarship is reportable on Form 1042-S and is subject to NRA withholding. For example, those portions of a scholarship devoted to travel, room, and board are subject to NRA withholding and are reported on Form 1042-S. The withholding rate is 14% on taxable scholarship and fellowship grants paid to nonresident aliens temporarily present in the United States in "F," "J," "M," or "Q" nonimmigrant status. Payments made to nonresident alien individuals in any other immigration status are subject to 30% withholding.

Taxmap/pubs/p515-004.htm#TXMP6bb562dd Nondegree candidate.

If the person receiving the scholarship or fellowship grant is not a candidate for a degree, and is present in the United States in "F,""J," "M," or "Q" nonimmigrant status, you must withhold tax at 14% on the total amount of the grant that is from U.S. sources if the following requirements are met.

1. The grant must be for study, training, or research at an educational organization in the United States.
2. The grant must be made by:
   1. A tax-exempt organization operated for charitable, religious, educational, etc. purposes,
   2. A foreign government,
   3. A federal, state, or local government agency, or
   4. An international organization, or a binational or multinational educational or cultural organization created or continued by the Mutual Educational and Cultural Exchange Act of 1961 (known as the Fulbright-Hays Act).

If the grant does not meet both (1) and (2) above, you must withhold at 30% on the amount of the grant that is from U.S. sources.

Taxmap/pubs/p515-004.htm#TXMP5779c1b1 Alternate withholding procedure.

You may choose to treat the taxable part of a U.S. source grant or scholarship as wages. The student or grantee must have been admitted into the United States on an "F," "J," "M," or "Q" visa. The student or grantee will know that you are using this alternate withholding procedure when you ask for a Form W-4.

The student or grantee must complete Form W-4 annually following the instructions given here and forward it to you, the payer of the scholarship, or your designated withholding agent. You may rely on the information on Form W-4 unless you know or have reason to know it is incorrect. You must file a Form 1042-S (discussed later) for each student or grantee who gives you, or your withholding agent, a Form W-4.

Each student or grantee who files a Form W-4 must file an annual U.S. income tax return to be allowed the exemptions and deductions claimed on that form. If the individual is in the United States during more than one tax year, he or she must attach a statement to the annual Form W-4 indicating that the individual has filed a U.S. income tax return for the previous year. If he or she has not been in the United States long enough to have to file a return, the individual must attach a statement to the Form W-4 saying that a timely U.S. income tax return will be filed.

A prorated portion of allowable personal exemptions based on the projected number of days he or she will be in this country is allowed. This is figured by multiplying the daily exemption amount ($8.77 for 2005) by the number of days the student or grantee expects to be in the United States during the year. The prorated exemption amount should be shown on line A of the Personal Allowances Worksheet that comes with Form W-4.

Generally, zero (-0-) should be shown on line B of the worksheet. But, a student or grantee who qualifies under Article 21(2) of the United States-India Income Tax Treaty can enter the standard deduction if he or she does not claim away-from-home expenses or other itemized deductions (discussed later).

Generally, zero (-0-) should be shown on lines C and D of the worksheet. But, an additional daily exemption amount may be allowed for the spouse and each dependent if the student or grantee is:

• A resident of Canada, Mexico, or South Korea,
• A U.S. national (a citizen of American Samoa, or a Northern Mariana Islander who chose to become a U.S. national), or
• Eligible for the benefits of Article 21(2) of the United States-India Income Tax Treaty.

These additional amounts should be entered on lines C and D, as appropriate.

As lines E, F, and G of the worksheet do not apply to nonresident aliens subject to this procedure, there should be no entries on those lines.

The nonresident alien student or grantee may deduct away-from-home expenses (meals, lodging, and transportation) on Form W-4 if he or she expects to be away from his or her tax home for 1 year or less. The amount of the claimed expenses should be the anticipated actual amount, if known. If the amount of the expenses is not known at the time the Form W-4 is filed with you, the current per diem allowance in effect for participants in the Career Education Program under the Federal Travel Regulations may be claimed on Form W-4. The allowable amount is $18.00 per day.

The actual expenses or the per diem allowance should be shown on line A of the worksheet in addition to the personal exemption amount.

The student or grantee can claim other expenses that will be deductible on Form 1040NR, U.S. Nonresident Alien Income Tax Return. These include student loan interest, certain state and local income taxes, charitable contributions, casualty losses, and moving expenses. He or she should include these anticipated amounts on line A of the worksheet.

The student or grantee can also enter on line A of the worksheet, the part of the grant or scholarship that is tax exempt under the statute or a tax treaty.

Lines A through D of the Personal Allowances Worksheet are added and the total should be shown on line H.

The payer of the grant or scholarship must review the Form W-4 to make sure all the necessary and required information is provided. If the withholding agent knows or has reason to know that the amounts shown on the Form W-4 may be false, the withholding agent must reject the Form W-4 and withhold at the appropriate statutory rate (14% or 30%). However, if the only incorrect information is that the student or grantee's stay in the United States has extended beyond 12 months, the withholding agent may withhold under these rules, but without a deduction for away-from-home expenses.

After receipt and acceptance of the Form W-4, the payer must withhold at the graduated rates in Publication 15 (Circular E) as if the grant or scholarship income were wages. The gross amount of the income is reduced by the total amount of exemptions and deductions on the Form W-4 and the withholding tax is figured on the rest.

When completing Form 1042-S for the student or grantee, enter the taxable part (gross amount less qualified scholarship) of the scholarship or fellowship grant in box 2, enter the withholding allowance amount from line H of the Personal Allowances Worksheet of Form W-4 in box 3, and show the net of these two amounts in box 4.

Taxmap/pubs/p515-004.htm#TXMP1969727c Pay for services rendered.

Pay for services rendered as an employee by an alien who also is the recipient of a scholarship or fellowship grant usually is subject to graduated withholding according to the rules discussed later in Wages Paid to Employees — Graduated Withholding. This includes taxable amounts an individual who is a candidate for a degree receives for teaching, doing research, and carrying out other part-time employment required as a condition for receiving the scholarship or fellowship grant.

Grants given to students, trainees, or researchers which require the performance of personal services as a necessary condition for disbursing the grant do not qualify as scholarship or fellowship grants. Instead, they are compensation for personal services considered to be wages. It does not matter what term is used to describe the grant (for example, stipend, scholarship, fellowship, etc.).

Withholding agents who pay grants that are in fact wages must report such grants on Forms 941 and W-2 and withhold income tax on them at the graduated rates. Withholding agents may not allow tax treaty exemptions that apply to scholarships and fellowships to be applied to grants which are really wages. It is the responsibility of the withholding agent to determine whether a grant is "wages" or a "scholarship or fellowship," and to report and withhold on the grant accordingly. An alien student, trainee, or researcher may not claim a scholarship or fellowship treaty exemption against income which has been reported to him on Form W-2 as wages.

Taxmap/pubs/p515-004.htm#TXMP0964f17d Per diem paid by the U.S. Government.

Per diem for subsistence paid by the U.S. Government (directly or by contract) to a nonresident alien engaged in a training program in the United States under the Mutual Security Act of 1954 (grants funded by the U.S. Agency for International Development) are not subject to 14% or 30% withholding. This is true even if the alien is subject to income tax on those amounts.

Taxmap/pubs/p515-004.htm#TXMP4d734a6c Tax treaties.

Many treaties contain exemptions from U.S. taxation for scholarships and fellowships. Although usually found in the student articles of the tax treaties, many of these exemptions also apply to research grants received by researchers who are not students. Table 2 of this publication shows a line entry entitled "Scholarship or fellowship grant" for those treaties which have such an exemption. The treaty provision usually exempts the entire scholarship or fellowship amount, regardless of whether the grant is a "qualified scholarship" under U.S. law.

An alien student, trainee, or researcher may claim a treaty exemption for a scholarship or fellowship by submitting Form W-8BEN to the payer of the grant. However, a scholarship or fellowship recipient who receives both wages and a scholarship or fellowship from the same institution can claim treaty exemptions on both kinds of income on Form 8233.

The scholarship or fellowship recipient who is claiming a treaty exemption must provide you with his or her TIN on Form W-8BEN or on Form 8233 or you cannot allow the treaty exemption. A copy of a completed Form W-7, showing that a TIN has been applied for, can be given to you with a Form 8233. See Form 8233, later under Pay for Personal Services Performed.

Taxmap/pubs/p515-004.htm#TXMP051e31b0 Nonresident alien who becomes a resident alien.

Generally, only a nonresident alien individual may use the terms of a tax treaty to reduce or eliminate U.S. tax on income from a scholarship or fellowship grant. A student (including a trainee or business apprentice) or researcher who has become a resident alien for U.S. tax purposes may be able to claim benefits under a tax treaty that apply to reduce or eliminate U.S. tax on scholarship or fellowship grant income. Most treaties contain a provision known as a "saving clause." An exception to the saving clause may permit an exemption from tax to continue for scholarship or fellowship grant income even after the recipient has otherwise become a U.S. resident alien for tax purposes. In this situation, the individual must give you a Form W-9 and an attachment that includes all the following information.

• The treaty country.
• The treaty article addressing the income.
• The article number (or location) in the tax treaty that contains the saving clause and its exceptions.
• The type and amount of income that qualifies for the exemption from tax.
• Sufficient facts to justify the exemption from tax under the terms of the treaty article.

Taxmap/pubs/p515-004.htm#TXMP3e8c1a3a
Example.

Article 20 of the U.S.-China income tax treaty allows an exemption from tax for scholarship income received by a Chinese student temporarily present in the United States. Under the Internal Revenue Code, a student may become a resident alien for tax purposes if his or her stay in the United States exceeds 5 calendar years. However, the treaty allows the provisions of Article 20 to continue to apply even after the Chinese student becomes a resident alien of the United States.

Taxmap/pubs/p515-004.htm#TXMP0c61bb86 Other Grants, Prizes, and Awards

Scholarships, Grants, Prizes, and Awards

Other grants, prizes, and awards made by grantors which reside in the United States are treated as income from sources within the United States. Those made for activities conducted outside the United States by a foreign person or by grantors which reside outside the United States are treated as income from foreign sources. These provisions do not apply to salaries or other pay for services.

Taxmap/pubs/p515-004.htm#TXMP70f42758 Grant.

The purpose of a grant must be to achieve a specific objective, produce a report or other similar product, or improve or enhance a literary, artistic, musical, scientific, teaching, or other similar capacity, skill, or talent of the grantee. A grant must also be an amount which does not qualify as a scholarship or fellowship. The grantor must not intend the amount to be given to the grantee for the purpose of aiding the grantee to perform study, training, or research.

Taxmap/pubs/p515-004.htm#TXMP41009ced Prizes and awards.

Prizes and awards are amounts received primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement, or are received as the result of entering a contest. A prize or award is taxable to the recipient unless all of the following conditions are met:

• The recipient was selected without any action on his or her part to enter the contest or proceeding,
• The recipient is not required to render substantial future services as a condition to receive the prize or award, and
• The prize or award is transferred by the payer to a governmental unit or tax-exempt charitable organization as designated by the recipient.

Taxmap/pubs/p515-004.htm#TXMP5c8e63b9 Targeted grants and achievement awards.

Targeted grants and achievement awards received by nonresident aliens for activities conducted outside the United States are treated as income from foreign sources. Targeted grants and achievement awards are issued by exempt organizations or by the United States (or one of its instruments or agencies), a state (or a political subdivision of a state), or the District of Columbia for an activity (or past activity in the case of an achievement award) undertaken in the public interest.

Taxmap/pubs/p515-004.htm#TXMP40ef563b Pay for Personal   Services Performed

Pay for Personal Services Performed

This section explains the rules for withholding tax from pay for personal services. You generally must withhold tax at the 30% rate on compensation you pay to a nonresident alien individual for labor or personal services performed in the United States, unless that pay is specifically exempted from withholding or subject to graduated withholding. This rule applies regardless of your place of residence, the place where the contract for service was made, or the place of payment.

Taxmap/pubs/p515-004.htm#TXMP435354bf Illegal aliens.

Foreign workers who are illegal aliens are subject to U.S. taxes in spite of their illegal status. U.S. employers or payers who hire illegal aliens may be subject to various fines, penalties, and sanctions imposed by U.S. Immigration and Customs Enforcement. If such employers or payers choose to hire illegal aliens, the payments made to those aliens are subject to the same tax withholding and reporting obligations that apply to other classes of aliens. Illegal aliens who are nonresident aliens and who receive income from performing independent personal services are subject to 30% withholding unless exempt under some provision of law or a tax treaty. Illegal aliens who are resident aliens and who receive income from performing dependent personal services are subject to the same reporting and withholding obligations which apply to U.S. citizens who receive the same kind of income.

Taxmap/pubs/p515-004.htm#TXMP076065ba Form 8233,

Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual, is used by a nonresident alien individual to claim a tax treaty exemption from withholding on some or all compensation paid for:

• Independent personal services (self-employment),
• Dependent personal services, or
• Personal services income and noncompensatory scholarship or fellowship income from the same withholding agent.

Persons providing independent personal services can use Form 8233 to claim the personal exemption amount.

A U.S. TIN must be shown on Form 8233. An individual with a visa that is valid for employment should first apply for a social security number (SSN) with the Social Security Administration (SSA). An individual that does not have, and is not eligible for, an SSN must apply for an ITIN by using Form W-7. The individual must provide proof that he or she applied for an SSN and was rejected by the SSA and include a copy of a completed Form 8233 with the Form W-7.

Taxmap/pubs/p515-004.htm#TXMP4b42b4dc Form W-4,

Employee's Withholding Allowance Certificate, is used by a person providing dependent personal services to claim the personal exemption amount, but not a tax treaty exemption. Nonresident alien individuals are subject to special instructions for completing the Form W-4. See the discussion under Wages Paid to Employees—Graduated Withholding, later.

Taxmap/pubs/p515-004.htm#TXMP5ab00581 Pay for independent personal services (Income Code 16).

Independent personal services (a term commonly used in tax treaties) are personal services performed by an independent nonresident alien contractor as contrasted with those performed by an employee. This category of pay includes payments for professional services, such as fees of an attorney, physician, or accountant made directly to the person performing the services. It also includes honoraria paid by colleges and universities to visiting teachers, lecturers, and researchers.

Pay for independent personal services is subject to NRA withholding and reporting as follows.

Taxmap/pubs/p515-004.htm#TXMP6e6bc18f 30% rate.

You must withhold at the statutory rate of 30% on all payments unless the alien enters into a withholding agreement or receives a final payment exemption (discussed later).

The amount of pay subject to 30% withholding may be reduced by the personal exemption amount ($3,200 for 2005) if the alien gives you a properly completed Form 8233. A nonresident alien is allowed only one personal exemption. However, individuals who are residents of Canada, Mexico, or South Korea, or are U.S. nationals (defined below) are generally entitled to the same exemptions as U.S. citizens.

Students and business apprentices covered by Article 21(2) of the United States-India Income Tax Treaty may claim an additional exemption for their spouse if a joint return is not filed, and if the spouse has no gross income for the year and is not the dependent of another taxpayer. They may also claim additional exemptions for children who reside with them in the United States at any time during the year, but only if the dependents are U.S. citizens or nationals or residents of the United States, Canada, or Mexico. They may not claim exemptions for dependents who are admitted to the United States on "F-2," "J-2," or "M-2" visas unless such dependents have become resident aliens.

Each allowable exemption must be prorated according to the number of days during the tax year during which the alien performs services in the United States. Multiply the number of these days by $8.77 (the daily exemption amount for 2005) to figure the prorated amount. Residents of South Korea must make a further proration of their additional exemptions based on their gross income effectively connected with a U.S. trade or business. The rules for this proration are discussed in detail in Publication 519.

A U.S. national is an individual who owes his sole allegiance to the United States, but who is not a U.S. citizen. Such an individual is usually a citizen of American Samoa, or a Northern Mariana Islander who chose to become a U.S. national.

Taxmap/pubs/p515-004.htm#TXMP4910fbef Example 1.

Hans Schmidt, who is a resident of Germany, worked (not as an employee) for a U.S. company in the United States for 100 days during 2005 before returning to his country. He earned $6,000 for the services performed (not considered wages) in the United States. Hans is married and has three dependent children. His wife did not work and had no income subject to U.S. tax. Hans is allowed $877 as a deduction against the payments for his personal services performed in the United States (100 days × $8.77). Tax must be withheld at 30% on the rest of his earnings, $5,123 ($6,000 − $877).

Taxmap/pubs/p515-004.htm#TXMP38dad9d4 Example 2.

If, in Example 1, Hans were a resident of Canada or Mexico or a national of the United States, working under contract with a domestic corporation, $4,385 (100 days × $8.77 per day for each of five exemptions) would be allowed against the payments for personal services performed in the United States. Tax must be withheld at 30% on the rest of his earnings, $1,615 ($6,000 − $4,385).

Taxmap/pubs/p515-004.htm#TXMP008020fd Withholding agreements.

Pay for personal services of a nonresident alien who is engaged during the tax year in the conduct of a U.S. trade or business may be wholly or partially exempted from withholding at the statutory rate if an agreement has been reached between the Commissioner or his delegate and the alien as to the amount of withholding required. This agreement will be effective for payments covered by the agreement that are made after the agreement is executed by all parties. The alien must agree to timely file an income tax return for the current tax year.

Taxmap/pubs/p515-004.htm#TXMP523c5c11 Final payment exemption.

The final payment of compensation for independent personal services may be wholly or partially exempt from withholding at the statutory rate. This exemption does not apply to wages paid to an employee. The nonresident alien must have been engaged during the tax year in the conduct of a U.S. trade or business. This exemption is available only once during an alien's tax year. It applies to the last payment of compensation, other than wages, for personal services rendered in the United States that the alien expects to receive from any withholding agent during the tax year.

To obtain the final payment exemption, the alien, or the alien's agent, must file the forms and provide the information required by the Commissioner or his delegate. This information includes, but is not limited to, the following items.

• A statement by each withholding agent from whom amounts of gross income effectively connected with the conduct of a U.S. trade or business have been received by the alien during the tax year. It must show the amount of income paid and the amount of tax withheld. The withholding agent must sign the statement and include a declaration that it is made under penalties of perjury.
• A statement by the withholding agent from whom the final payment of compensation for personal services will be received showing the amount of final payment and the amount that would be withheld if a final payment exemption is not granted. The withholding agent must sign the statement and include a declaration that it is made under penalties of perjury.
• A statement by the alien that he or she does not intend to receive any other amounts of gross income effectively connected with the conduct of a U.S. trade or business during the current tax year.
• The amount of tax that has been withheld (or paid) under any other provision of the Code or regulations for any income effectively connected with the conduct of a U.S. trade or business during the current tax year.
• The amount of any outstanding tax liabilities, including any interest and penalties, from the current tax year or prior tax periods.
• The provision of any income tax treaty under which a partial or complete exemption from withholding may be claimed, the country of the alien's residence, and a statement of sufficient facts to justify an exemption under that treaty.

The alien must give a statement, signed and verified by a declaration that it is made under the penalties of perjury, that all the information provided is true, and that to his or her knowledge no relevant information has been omitted.

If satisfied with the information provided, the Commissioner or his delegate will determine the amount of the alien's tentative income tax for the tax year on gross income effectively connected with the conduct of a U.S. trade or business. Ordinary and necessary business expenses may be taken into account if proved to the satisfaction of the Commissioner or his delegate.

The Commissioner or his delegate will provide the alien with a letter to you, the withholding agent, stating the amount of the final payment of compensation for personal services that is exempt from withholding, and the amount that would otherwise be withheld that may be paid to the alien due to the exemption. The amount of pay exempt from withholding cannot be more than $5,000. The alien must give two copies of the letter to you and must also attach a copy of the letter to his or her income tax return for the tax year for which the exemption is effective.

Taxmap/pubs/p515-004.htm#TXMP497ead16 Travel expenses.

If you pay or reimburse the travel expenses of a nonresident alien, the payments are not reportable to the IRS and are not subject to NRA withholding if the payments are made under an accountable plan as described in section 1.62-2 of the regulations. This treatment applies only to that portion of a payment that represents the payment of travel and lodging expenses and not to that portion that represents compensation for independent personal services.

Taxmap/pubs/p515-004.htm#TXMP33a99d3a Tax treaties.

Under most tax treaties, pay for independent personal services performed in the United States is exempt from U.S. income tax only if the independent nonresident alien contractor performs the services during a period of temporary presence in the United States (usually not more than 183 days) and is a resident of the treaty country.

Independent nonresident alien contractors use Form 8233 to claim an exemption from withholding under a tax treaty. For more information, see Form 8233, earlier.

Often, you must withhold under the statutory rules on payments made to a treaty country resident contractor for services performed in the United States. This is because the factors on which the treaty exemption is based may not be determinable until after the close of the tax year. The contractor must then file a U.S. income tax return (Form 1040NR) to recover any overwithheld tax by providing the IRS with proof that he or she is entitled to a treaty exemption.

Taxmap/pubs/p515-004.htm#TXMP3d49c7f1 Wages Paid to Employees—   Graduated Withholding

Wages Paid to Employees— Graduated Withholding

Salaries, wages, bonuses, or any other pay for personal services (referred to collectively as wages) paid to nonresident alien employees are subject to graduated withholding in the same way as for U.S. citizens and residents if the wages are effectively connected with the conduct of a U.S. trade or business. Any wages paid to a nonresident alien for personal services performed as an employee for an employer are generally exempt from the 30% withholding if the wages are subject to graduated withholding.

Also exempt from the 30% withholding is pay for personal services performed as an employee for an employer if it is effectively connected with the conduct of a U.S. trade or business and is specifically excepted from wages. See Pay that is not wages, later.

Taxmap/pubs/p515-004.htm#TXMP6c0c55ae Employer-employee relationship.

For pay for personal services to qualify as wages, there must be an employer-employee relationship.

Under the common law rules, every individual who performs services subject to the will and control of an employer, both as to what shall be done and how it shall be done, is an employee. It does not matter that the employer allows the employee considerable discretion and freedom of action, as long as the employer has the legal right to control both the method and the result of the services.

If an employer-employee relationship exists, it does not matter what the parties call the relationship. It does not matter if the employee is called a partner, coadventurer, agent, or independent contractor. It does not matter how the pay is measured, how the individual is paid, or what the payments are called. Nor does it matter whether the individual works full-time or part-time.

The existence of the employer-employee relationship under the usual common law rules will be determined, in doubtful cases, by an examination of the facts of each case.