Understanding U.S. Tax Obligations: A Guide for International Students and Educational Institutions
Originally published on September 18, 2023
The U.S. tax system and its intricate rules and regulations can seem overwhelming, particularly for international students. This guide provides an overview of tax obligations and potential benefits for international students studying in the U.S., as well as the responsibilities of the academic institutions that provide financial aid.
Understanding Tax Requirements
The Internal Revenue Service (IRS) classifies international students as either nonresident aliens or resident aliens, depending on their visa type and the number of days spent in the US. This classification determines the tax rules that apply to them. International students receiving taxable grants, scholarships, salaries or other domestic sources of income must file taxes, regardless of the amount.
Scholarships and Financial Aid: A Closer Look
When academic institutions award scholarships or fellowship grants to international students, they act as withholding agents. And most foreign students are considered foreign persons for U.S. tax purposes.
All or a portion of a scholarships or grant may be considered U.S. source taxable income and subject to U.S. withholding tax, with the standard withholding tax rate being 30%. In most circumstances, however, scholarships and grants qualify for a reduced 14% withholding rate. This rate could be further reduced under an income tax treaty agreement — depending on the international student’s situation — between the United States and the student’s home country. (We’ll talk more about income tax treaties shortly.)
Nonqualified Scholarships and Compensatory Scholarships
Nonqualified scholarships include funds disbursed for expenses not directly related to tuition or related qualified expenses. Typical examples include optional fees, books, room, board, travel and personal expenses. There is a 14% withholding rate for nonqualified scholarships; the rate could also be reduced through an income tax treaty.
There’s also the question of compensatory scholarships for international students. If a scholarship requires a student to work in order to receive some or all of the funding, it is seen as compensatory. That portion of the funding must be treated as wages, and those “wages” are taxable at ordinary U.S. income tax rates.
If the scholarship is compensatory and requires a student to work part-time as a condition of receiving the funds, the portion of the scholarship considered compensatory is not exempt from withholding tax and should be treated as wages. These are taxable to the recipient at U.S. ordinary income tax rates.
Degree vs. Non-Degree Candidates: Different Tax Implications
- The tax implications for international students can vary significantly based on whether they are degree candidates or non-degree candidates. Per IRS Publication 970, degree candidates in the U.S. holding visas beginning with F, J, M or Q are exempt from withholding on qualified scholarships.
- Non-degree candidates are subject to withholding at a rate of 14%. The grant must come from a tax-exempt organization and be used for study, training or research in the United States.
Your institution is the payer of the financial aid and withholding agent. This requires the institution to withhold the applicable tax for international students and remit it to the U.S Treasury. This must be done based on a specific schedule and via the Electronic Federal Tax Payment System (EFTPS). You’re also required to file IRS Form 1042 every year. This form, which summarizes the amounts deposited, should reflect the amounts on IRS Forms 1042-S given to recipients of the financial aid.
The Obligations of International Students
International students receiving financial aid must obtain a U.S. taxpayer identification number, report their status to the educational institution and fulfill tax filing obligations. The effect of visa status on tax filing obligation is also significant. For instance, a student with an F-1 visa is treated as a non-resident alien for a five-year period, regardless of how much of that time is spent in the U.S. during this period.
What Are Income Tax Treaties?
The U.S. maintains income tax treaties with countries around the world. These treaties provide different rules for taxation of nationals and override the U.S. federal and state withholding laws. This allows those nationals to reduce (or even avoid entirely) withholding tax on funds normally subject to them.
While the U.S. tax system is complex, understanding the basic requirements and potential benefits can make the process more manageable for international students. It’s crucial for students to understand their tax filing and visa status, report their income sources correctly, and check if they are exempt from any rules due to income tax treaties.
While we’ve outlined the basics of U.S. tax law as it relates to international students, there are countless nuances and subtle details to consider as well. International students should seek professional tax advice to ensure they’re meeting their obligations and taking advantage of available benefits. Institutions like yours also have a responsibility to understand and meet their obligations as withholding agents.
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.
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