A nonresident alien's treaty income is the gross income on which the tax is limited by a tax treaty. Treaty income includes, for example, dividends
from sources in the United States that are subject to tax at a tax treaty rate not to exceed 15%. Nontreaty income is the gross income of a
nonresident alien on which the tax is not limited by a tax treaty.
Figure the tax on treaty income on each separate item of income at the reduced rate that applies to that item under the treaty.
To determine tax on nontreaty income, figure the tax at either the flat 30% rate or the graduated rate, depending upon whether or not the income is
effectively connected with your trade or business in the United States.
Your tax liability is the sum of the tax on treaty income plus the tax on nontreaty income, but cannot be more than the tax liability figured as if
the tax treaty had not come into effect.
Example.
Arthur Banks is a nonresident alien who is single and a resident of a foreign country that has a tax treaty with the United States. He received
gross income of $25,500 during the tax year from sources within the United States, consisting of the following items:
| Dividends on which the tax is limited to a 15% rate by the tax treaty |
$1,400 |
| Compensation for personal services on
which the tax is not limited
by the tax treaty |
24,100 |
| Total gross income |
$25,500 |
Arthur was engaged in business in the United States during the tax year. His dividends are not effectively connected with that business. He has no
deductions other than his own personal exemption.
His tax liability, figured as though the tax treaty had not come into effect, is $3,304, determined as follows:
| Total compensation |
$24,100 |
| Less: Personal exemption |
2,900 |
| Taxable income |
$21,200 |
| Tax determined by graduated rate ( Tax Table column for single taxpayers) |
$2,884 |
| Plus: Tax on gross dividends ($1,400 × 30%) |
420 |
| Tax determined as though treaty had not come into effect |
$3,304 |
Arthur's tax liability, figured by taking into account the reduced rate on dividend income as provided by the tax treaty, is $3,094, determined as
follows:
| Tax determined by graduated rate (same as figured above) |
$2,884 |
| Plus: Tax on gross dividends ($1,400 × 15%) |
210 |
| Tax on compensation and dividends |
$3,094 |
His tax liability, therefore, is limited to $3,094, the tax liability figured using the tax treaty rate on the dividends.
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