Students across the world choose to pursue their higher education in different countries. The US is one of the preferred options due to its renowned higher education programmes, distinctive curriculum, diverse culture, and career prospects.
After admission, a student requires a valid visa to enter the US. Global students are generally issued a “F," “J," “M," or “Q" visa. This article provides a broad overview to foreign students on some of the important tax aspects that they should keep in mind, like the tax residency status, tax implications and capital gains.
Tax residency status
For tax purposes, an individual is considered as a resident of the US if he/she meets the substantial presence test for any calendar year. Thus, an individual must be physically present in the US for at least:
- 31 days during the current calendar year; and
- 183 days during the three-year period that includes the current year, preceding year and the year preceding to it, as below:
- All the days present in the current calendar year, and
- 1/3 of the days present in the preceding calendar year, and
- 1/6 of the days present in the year prior to the preceding calendar year
However, there are exceptions to this rule. If the individual is an “Exempt individual", the days of presence in the US for the purposes of substantial presence test are not considered.
As per US Internal Revenue Service (IRS), a foreign student temporarily present in the US under a “F," “J," “M," or “Q" visa who substantially complies with the requirements of the visa is considered as an “Exempt individual" for US tax purposes, for specified calendar years.
A foreign student is considered to have substantially complied with the visa requirements if he/she has not engaged in activities that are prohibited by US immigration laws which could result in the loss of his/her visa status. Basis this, foreign students with applicable visa type such as F-1 visa are exempt from the substantial presence test for five calendar years and are considered as non-resident alien (a non-US citizen who has not passed the green card test or the substantial presence test) for those calendar years.
It is pertinent to note that the five calendar years for the exemption need not be consecutive years. Also, the presence of a foreign student for a part of the year will be considered as one complete tax year for exemption purposes. For example, if a foreign student enters the US on 1st December 2020, then year 2020 will be treated as the first year for the 5-year exemption.
However, a foreign student can continue to avail of the exemption from the substantial presence test even after 5 calendar years, if the following conditions are met:
- he/she establishes that he/she does not intend to reside permanently in the US.
- he/she has substantially complied with the requirements of his/her visa.
The facts and circumstances to be considered in determining if he/she has demonstrated an intent to reside permanently in the US include, but are not limited to, the following:
- Whether he/she has maintained a closer connection to a foreign country.
- Whether he/she has taken affirmative steps to change his/her status from non-immigrant to lawful permanent resident.
There is no minimum dollar amount of income that triggers a filing requirement for a non-resident alien including a foreign student or a foreign scholar in the US. Generally, students earn following types of income while studying in the US:
- scholarship/fellowship grants, covering tuition, fees, books, room/board, and/or travel.
- compensation for services rendered, usually as a part-time employee while attending school or as a graduate teaching or research assistant; and
- income from savings, such as interest from US bank account etc.
The US only taxes non-resident aliens on their income, which is effectively connected with a US trade or business known as ECI (Effectively Connected Income- ECI income is defined as income from operating a US business) and on their US-source Fixed, Determinable, Annual or Periodical (FDAP) income (interest and dividends) that is not effectively connected with a US trade or business. The ECI is taxed at the normal graduated tax rates applicable to US citizens, while the FDAP income is generally taxed at a flat rate of 30%.
Receipt of fellowship grant
Receipt of fellowship/scholarship grant is considered as income effectively connected with the conduct of trade or business in the US and may be taxable at the normal graduated tax rates as applicable to the US citizens.
While one would normally expect that taxable scholarships and fellowship grants would not be treated as connected with a US trade or business, and therefore would be taxed at the flat rate of 30%, assuming they constituted FDAP income, however this is not the case.
It is important to note that the payment a foreign student receives as a scholarship or fellowship grant will be taxable or not would depend on whether the grant is US-source or foreign-source income (assuming no exclusion might apply).
To determine if the grant received by the student is foreign-sourced or US-sourced income, the IRS has concluded that such grants be considered to be sourced, where the principal economic nexus exists, namely, the residence of the payor of the grant. Hence, scholarships and fellowship grants are linked to the residence of the person or entity making the grant and not at the location where the student is studying, which was the criteria for sourcing grants before 1989. Therefore, the grant treated as foreign-sourced income is not taxable in the US. If the scholarship or fellowship grant is determined to be US-sourced and it does not qualify for any of the exclusions, then it becomes taxable in the US.
Compensation for Services
If a foreign student derives compensation for services rendered and that compensation is US-sourced income as the services were performed in the US, the non-resident alien is considered to be engaged in a US trade or business and the US-source income constitutes an ECI. If the non-resident alien has other compensation income that is foreign-sourced because the services generating that income were performed outside the US, the performance of those services does not give rise to a US trade or business and the foreign-source compensation income is not ECI and will not be taxed in the US. However, ECI is taxed at the same graduated rates that apply to compensation income earned by US citizens.
Capital gains tax exemption
Gain or loss from the sale or exchange of personal property will have its source in the US if the non-resident alien has a tax home in the US. Specifically, a foreign student will establish a tax home in the US if he/she is employed in the US under any applicable non-immigrant status and is the recipient of a US source scholarship or fellowship. If the foreign student does not have a tax home in the US, then the alien’s capital gains would be treated as foreign source and will not be taxable in the US. Further, the foreign student shall not be taxable on his US source capital gains income in any calendar year in which his presence in the US does not equal or exceed 183 days.
Student FICA tax exemption
Taxes under the Federal Contribution Insurance Act (‘FICA’) are composed of the old-age, survivors, and disability insurance taxes, also known as social security taxes, and the hospital insurance tax, also known as Medicare taxes. The Internal Revenue Code imposes the liability for Social Security and Medicare taxes on both the employer and the employee, who earns income from wages in the US. The student or scholar will be exempt from Social security and Medicare taxes on wages paid to them for services performed in the US as long as the foreign student complies with his / her visa requirement.
Exempt employment includes on-campus employment up to 20 hours a week (40 hours during summer vacations), off-campus student employment allowed by United States Citizenship and Immigration Services, practical training student employment on or off campus and employment as a summer camp worker.
However, if a foreign student has become a resident alien, the student may still get an exemption from the Social Security and Medicare tax under the “student FICA exemption". FICA taxes do not apply to service performed by students employed by a school, college or university where the student is pursuing a course of study. Any individual who is a half-time undergraduate, graduate or professional student will qualify for the student FICA exemption.
In conclusion, students travelling to the US for higher education should understand and evaluate their tax residency status and any tax obligations. It is best to remain fully compliant and avoid any adverse implications under the US tax laws.