8. Paying Tax Through Withholding or Estimated Tax

Introduction

This chapter discusses how to pay your U.S. income tax as you earn or receive income during the year. In general, the federal income tax is a pay as you go tax. There are two ways to pay as you go.

1. Withholding. If you are an employee, your employer probably withholds income tax from your pay. Tax may also be withheld from certain other income - including pensions, bonuses, commissions, and gambling winnings. In each case, the amount withheld is paid to the U.S. Treasury in your name.
2. Estimated tax. If you do not pay your tax through withholding, or do not pay enough tax that way, you might have to pay estimated tax. People who are in business for themselves generally will have to pay their tax this way. You may have to pay estimated tax if you receive income such as dividends, interest, rent, and royalties. Estimated tax is used to pay not only income tax, but self-employment tax and alternative minimum tax as well.

Topics This chapter discusses:

• How to notify your employer of your alien status,
• Income subject to withholding of income tax,
• Exemptions from withholding,
• Social security and Medicare taxes, and
• Estimated tax rules.

Useful Items You may want to see:

Publication

• 515   Withholding of Tax on Nonresident Aliens and Foreign Entities
• 533   Self-Employment Tax
• 901   U.S. Tax Treaties

Form (and Instructions)

• W-4   Employee's Withholding Allowance Certificate
• W-8BEN   Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding
• W-8ECI   Certificate of Foreign Person's Claim for Exemption From Withholding on Income Effectively Connected With the Conduct of a Trade or Business in the United States
• W-9   Request for Taxpayer Identification Number and Certification
• 1040-ES(NR)   U.S. Estimated Tax for Nonresident Alien Individuals
• 8233   Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual
• 8288-B   Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests

See chapter 12 for information about getting these publications and forms.

Notification of Alien Status

You must let your employer know whether you are a resident or a nonresident alien so your employer can withhold the correct amount of tax from your wages.

If you are a resident alien under the rules discussed in chapter 1, you may file Form W-9 or a similar statement with your employer. If you are a nonresident alien under those rules, you must furnish to your employer Form 8233 or Form W-8BEN, establishing that you are a foreign person, or Form W-4, establishing that your compensation is subject to graduated withholding at the same rates as resident aliens or U.S. citizens.

If you are a resident alien and you receive income other than wages (such as dividends and royalties) from sources within the United States, you may file Form W-9 or similar statement with the withholding agent (generally, the payer of the income) so the agent will not withhold tax on the income at the 30% (or lower treaty) rate. If you receive this type of income as a nonresident alien, file Form W-8BEN with the withholding agent so that the agent will withhold tax at the 30% (or lower treaty) rate. However, if the income is effectively connected with a U.S. trade or business, file Form W-8ECI instead.

Withholding From Compensation

The following discussion generally applies only to nonresident aliens. Tax is withheld from resident aliens in the same manner as U.S. citizens.

Wages and other compensation paid to a nonresident alien for services performed as an employee are usually subject to graduated withholding at the same rates as resident aliens and U.S. citizens. Therefore, your compensation, unless it is specifically excluded from the term wages by law, or is exempt from tax by treaty, is subject to graduated withholding.

Withholding on Wages

If you are an employee and you receive wages subject to graduated withholding, you will be required to fill out a Form W-4. Nonresident aliens should fill out Form W-4 using the following instructions instead of the instructions on the Form W-4. This is because of the restrictions on a nonresident alien's filing status, the limited number of personal exemptions a nonresident alien is allowed, and because a nonresident alien cannot claim the standard deduction.

1. Check only Single marital status on line 3 (regardless of your actual marital status).
2. Claim only one allowance on line 5, unless you are a resident of Canada, Mexico, Japan, or South Korea, or a U.S. national.
3. Request that your employer withhold an additional amount of $7.60 per week on line 6. If your wages are paid based on a 2-week pay period, the additional amount will be $15.30. For other payroll periods, ask your employer for the amount to enter.
4. Do not claim Exempt withholding status on line 7.

A U.S. national is an individual who, although not a U.S. citizen, owes his or her allegiance to the United States. U.S. nationals include American Samoans, and Northern Mariana Islanders who chose to become U.S. nationals instead of U.S. citizens.

See Withholding on Scholarships and Fellowship Grants, later, for how to fill out Form W-4 if you receive a U.S. source scholarship or fellowship grant.

Students and business apprentices from India.   If you are eligible for the benefits of Article 21(2) of the United States-India Income Tax Treaty, you may claim additional withholding allowances for the standard deduction and your spouse. You may also claim an additional withholding allowance for each of your dependents not admitted to the United States on F-2, J-2, or M-2 visas if they meet the same rules that apply to U.S. citizens. You do not have to request additional withholding on line 6.

Wages Exempt From Withholding

Wages that are exempt from U.S. income tax under an income tax treaty are generally exempt from withholding. For information on how to claim an exemption from withholding, see Income Entitled to Tax Treaty Benefits, later.

Wages paid to aliens who are residents of Canada, Mexico, Puerto Rico, or the U.S. Virgin Islands may be exempt from withholding. The following paragraphs explain these exemptions.

Residents of Canada or Mexico engaged in
transportation-related employment.   Certain residents of Canada or Mexico who enter or leave the United States at frequent intervals are not subject to withholding on their wages. These persons either:

1. Perform duties in transportation service between the United States and Canada or Mexico, or
2. Perform duties connected to the construction, maintenance, or operation of a waterway, viaduct, dam, or bridge crossed by, or crossing, the boundary between the United States and Canada or the boundary between the United States and Mexico.

This employment is subject to withholding of social security and Medicare taxes unless the services are performed for a railroad.

To qualify for the exemption from withholding during a tax year, a Canadian or Mexican resident must give the employer a statement in duplicate with name, address, and identification number, certifying that the resident:

1. Is not a U.S. citizen or resident,
2. Is a resident of Canada or Mexico, whichever applies, and
3. Expects to perform duties previously described during the tax year in question.

The statement can be in any form, but it must be dated and signed by the employee and must include a written declaration that it is made under the penalties of perjury.

Residents of Puerto Rico.   If you are a nonresident alien employee who is a resident of Puerto Rico, wages for services performed in Puerto Rico are generally not subject to withholding unless you are an employee of the United States or any of its agencies in Puerto Rico.

Residents of the U.S. Virgin Islands.   Nonresident aliens who are bona fide residents of the Virgin Islands are not subject to withholding of U.S. tax on income earned while temporarily employed in the United States. This is because those persons pay their income tax to the Virgin Islands. To avoid having tax withheld on income earned in the United States, bona fide residents of the Virgin Islands should write a letter, in duplicate, to their employers, stating that they are bona fide residents of the Virgin Islands and expect to pay tax on all income to the Virgin Islands.

Withholding on Pensions

If you receive a pension as a result of personal services performed in the United States, the pension income is subject to the 30% (or lower treaty) rate of withholding. You may, however, have tax withheld at graduated rates on the portion of the pension that arises from the performance of services in the United States after December 31, 1986. You must fill out Form W-8ECI and give it to the withholding agent or payer before the income is paid or credited to you.

Withholding on Tip Income

Tips you receive during the year for services performed in the United States are subject to U.S. income tax. Include them in taxable income. In addition, tips received while working for one employer, amounting to $20 or more in a month, are subject to graduated withholding.

Independent Contractors

If there is no employee-employer relationship between you and the person for whom you perform services, your compensation is subject to the 30% (or lower treaty) rate of withholding. However, if you are engaged in a trade or business in the United States during the tax year, your compensation for personal services as an independent contractor (independent personal services) may be entirely or partly exempt from withholding if you reach an agreement with the Internal Revenue Service on the amount of withholding required. Also, the final payment to you during the tax year for independent personal services may be entirely or partly exempt from withholding if you are engaged in a trade or business in the United States during the year and you file the forms and provide the information required by the IRS.

Withholding Agreement

An agreement that you reach with the IRS regarding withholding from your compensation for independent personal services is effective for payments covered by the agreement after it is agreed to by all parties. You must agree to timely file an income tax return for the current tax year.

Central withholding agreements.   If you are a nonresident alien entertainer or athlete performing or participating in athletic events in the United States, you may be able to enter into a withholding agreement with the IRS for reduced withholding provided certain requirements are met. Under no circumstances will such a withholding agreement reduce taxes withheld to less than the anticipated amount of income tax liability.

Nonresident alien entertainers or athletes requesting a central withholding agreement must submit the following information.

1. A list of the names and addresses of the nonresident aliens to be covered by the agreement.
2. Copies of all contracts that the aliens or their agents and representatives have entered into regarding the time period and performances or events to be covered by the agreement including, but not limited to, contracts with:
   1. Employers, agents, and promoters,
   2. Exhibition halls,
   3. Persons providing lodging, transportation, and advertising, and
   4. Accompanying personnel, such as band members or trainers.
3. An itinerary of dates and locations of all events or performances scheduled during the period to be covered by the agreement.
4. A proposed budget containing itemized estimates of all gross income and expenses for the period covered by the agreement, including any documents to support these estimates.
5. The name, address, and telephone number of the person the IRS should contact if additional information or documentation is needed.
6. The name, address, and employer identification number of the agent or agents who will be the central withholding agents for the aliens and who will enter into a contract with the IRS. A central withholding agent ordinarily receives contract payments, keeps books of account for the aliens covered by the agreement, and pays expenses (including tax liabilities) for the aliens during the period covered by the agreement.

When the IRS approves the estimated budget and the designated central withholding agents, the Associate Chief Counsel (International) will prepare a withholding agreement. The agreement must be signed by each withholding agent, each nonresident alien covered by the agreement, and the Commissioner of the Internal Revenue Service or his delegate.

Generally, each withholding agent must agree to withhold income tax from payments made to the nonresident alien, to pay over the withheld tax to the IRS on the dates and in the amounts specified in the agreement, and to have the IRS apply the payments of withheld tax to the withholding agent's Form 1042 account. Each withholding agent will be required to file Form 1042 and Form 1042-S for each tax year in which income is paid to a nonresident alien covered by the withholding agreement. The IRS will credit the withheld tax payments, posted to the withholding agent's Form 1042 account, in accordance with the Form 1042-S. Each nonresident alien covered by the withholding agreement must agree to file Form 1040NR or Form 1040NR-EZ.

A request for a central withholding agreement should be sent to the following address at least 90 days before the agreement is to take effect.

Internal Revenue Service
Compliance Area Director, Area 15
950 L'Enfant Plaza South, S.W.
S:C:15
Washington, DC 20024

Final payment exemption.   Your final payment of compensation during the tax year for independent personal services may be entirely or partly exempt from withholding. This exemption is available only once during your tax year and applies to a maximum of $5,000 of compensation. To obtain this exemption, you or your agent must give the following statements and information to the Commissioner or his delegate.

1. A statement by each withholding agent from whom you have received gross income effectively connected with a trade or business in the United States during the tax year, showing the amount of income paid and the tax withheld. Each statement must be signed by the withholding agent and verified by a declaration that it is made under penalties of perjury.
2. A statement by the withholding agent from whom you expect to receive the final payment of compensation, showing the amount of the payment and the amount of tax that would be withheld if a final payment exemption were not granted. This statement must also be signed by the withholding agent and verified by a declaration that it is made under penalties of perjury.
3. A statement by you that you do not intend to receive any other income effectively connected with a trade or business in the United States during the current tax year.
4. The amount of tax that has been withheld or paid under any other provision of the Internal Revenue Code or regulations for any income effectively connected with your trade or business in the United States during the current tax year.
5. The amount of your outstanding tax liabilities, if any, including interest and penalties, from the current tax year or prior tax periods.
6. Any provision of an income tax treaty under which a partial or complete exemption from withholding may be claimed, the country of your residence, and a statement of sufficient facts to justify an exemption under the treaty.
7. A statement signed by you, and verified by a declaration that it is made under penalties of perjury, that all the information given is true and that to your knowledge no relevant information has been omitted.

If satisfied with the information, the IRS will determine the amount of your tentative income tax for the tax year on gross income effectively connected with your trade or business in the United States. Ordinary and necessary business expenses can be taken into account if proven to the satisfaction of the Commissioner or his delegate.

The Commissioner or his delegate will send you a letter, directed to the withholding agent, showing the amount of the final payment of compensation that is exempt from withholding and the amount that can be paid to you because of the exemption. You must give two copies of the letter to the withholding agent and must also attach a copy of the letter to your income tax return for the tax year for which the exemption is effective.

Allowance for Personal Exemption

Withholding on payments for independent personal services is generally based on the amount of your compensation payment minus the value of one exemption ($3,000 for 2002).

To determine the income for independent personal services performed in the United States to which the 30% (or lower treaty) rate will apply, you are allowed one personal exemption if you are not a U.S. national and are not a resident of Canada, Mexico, Japan, or South Korea. For purposes of 30% withholding, the exemption is prorated at $8.22 a day in 2002 for the period that labor or personal services are performed in the United States. To claim an exemption from withholding on the personal exemption amount, fill out the applicable parts of Form 8233 and give it to the withholding agent.

Example.   Eric Schmidt, who is a resident of Germany, worked under a contract with a U.S. firm (not as an employee) in the United States for 100 days during 2002 before returning to his country. He earned $6,000 for the services performed (not considered wages) in the United States. Eric is married and has three dependent children. His wife is not employed and has no income subject to U.S. tax. The amount of the personal exemption to be allowed against the income for his personal services performed within the United States in 2002 is $822 (100 days × $8.22), and withholding at 30% is applied against the balance. Thus, $1,553.40 in tax is withheld from Eric's earnings (30% of $5,178 ($6,000 - $822)).

U.S. nationals or residents of Canada, Mexico, Japan, or South Korea.   If you are a nonresident alien who is a resident of Canada, Mexico, Japan, or South Korea, or who is a national of the United States, you are subject to the same 30% withholding on your compensation for independent personal services performed in the United States. However, if you are a U.S. national or a resident of Canada or Mexico, you are allowed the same personal exemptions as U.S. citizens. For the 30% (or lower treaty rate) withholding, you can take $8.22 per day for each allowable exemption in 2002. If you are a resident of Japan or Korea, you are allowed personal exemptions for yourself and for your spouse and children who live with you in the United States at any time during the tax year. However, the additional exemptions for your spouse and children must be further prorated as explained in chapter 5 under Exemptions.

Students and business apprentices from India.   If you are eligible for the benefits of Article 21(2) of the United States-India Income Tax Treaty, you are allowed an exemption for your spouse only if your spouse has no gross income and is not the dependent of another taxpayer. You are also allowed an exemption for each dependent not admitted to the United States on F-2, J-2, or M-2 visas if they meet the same rules that apply to U.S. citizens. For the 30% (or lower treaty rate) withholding on compensation for independent personal services performed in the United States, you are allowed $8.22 per day for each allowable exemption in 2002.

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