Many U.S. colleges and universities recruit
foreign students, especially for graduate programs
and athletics. Such students often receive full
scholarships that include room and board, making
them subject to U.S. income taxes. These
students may be unfamiliar with the U.S. tax system,
but they need to understand how some financial aid
can be taxed, particularly if their homeland lacks a
tax treaty with the United States.
Generally, the portion of a scholarship paid for
tuition or related expenses under IRC § 117(b)(2) is
not taxable for any degree candidate, while any
portion paid for room and board or other
nonqualified expenses is subject to U.S. taxes.
Nonqualified expenses also include travel, research,
clerical help or equipment or supplies not necessary
for enrollment or attendance. In addition, the
portion of a scholarship that is compensation for
teaching or other services is taxable. U.S.
colleges and universities are not required to report
scholarships to the IRS if the recipient is a U.S.
citizen or resident alien. But for the majority of
foreign students who are nonresident aliens, the IRS
has established a reporting and withholding system,
generally at a rate of 14%. See IRC § 1441(b). The
university reports the income and taxes withheld on
an information return, Form 1042-S, Foreign
Person’s U.S. Source Income Subject to Withholding
.
A NEGATIVE ACCOUNT BALANCE
This withholding can be a problem for many
foreign students. Most scholarships that include
room and board are for exactly those costs, with no
additional money included for taxes. Therefore, the
withholding is often charged against a student’s
university account, creating a negative balance.
Usually, the deficit must be cleared for the student
to graduate or receive a college degree or
transcript. Unaware of the extra cost, foreign
students often do not budget for it. The problem is
compounded for the many foreign students who hold a
student visa, which prevents them from working for a
U.S. employer to earn money. Under some
countries’ tax treaties with the United States, room
and board scholarship income is not subject to
taxation. Even for students from those countries,
however, the university may issue a Form 1042-S and
withhold taxes unless the student alerts it that
withholding is not required. Such notification is by
Form W-8BEN, Certificate of Foreign Status of
Beneficial Owner for United States Tax Withholding
. Form W-8BEN is required for foreign students
to claim an exemption from withholding when they are
from countries with which the United States has an
income tax treaty. Therefore, it is the foreign
students’ responsibility to know the terms of their
country’s tax treaty with the U.S. Depending on the
treaty, a university may report a zero amount on a
1042-S. IRS publication 901, U.S. Tax Treaties
, may be useful in determining a student’s
status, as may be Volunteer Income Tax Assistance
training materials at www.irs.gov/app/vita/foreign_student_module.jsp
. The amount of treaty benefit is unlimited in
most cases. However, most treaties limit how long
the benefit is available, typically a maximum of
five years.
FILING 1040NR
Nonresident aliens with taxable income
generally are required to file a return on Form
1040NR or 1040NR-EZ. This requirement is not
well-understood by many foreign students, who often
mistakenly file Form 1040, or by some tax return
preparers, whose electronic preparation systems
likely won’t accept a 1040NR. A 1040NR cannot be
filed electronically with the IRS, either.
In computing their taxable income on 1040NR,
foreign students typically can deduct only a
personal exemption, which for 2008 is $3,500. No
standard deduction is permitted, so any income in
excess of $3,500 will usually be taxed at the 10%
rate. For example, a student who received a
scholarship including $7,500 to cover room and board
would have $1,050 ($7,500 x 14%) withheld and
charged against a student account. When filing Form
1040NR, this studen would compute an income tax of
approximately $400 [($7,500 - $3,500 personal
exemption) x 10%] and receive a refund of $650
($1,050 - $400). Other problems for foreign
student scholarship recipients may include the lack
of an individual tax identification number (ITIN).
Unless an exception applies, Form W-7,
Application for IRS Individual Taxpayer
Identification Number , must be accompanied
by an original, completed return. The IRS will
assign an ITIN, which the Service says can take up
to 10 weeks, and then process the return. An ITIN is
also required on Form 1042-S to claim a zero or
reduced rate of withholding under a tax treaty.
By Marc I. Lebow, CPA, Ph.D.,
and Michael McLain, CPA, DBA,
both of Hampton University, Hampton, Va., and
Wayne Schell, CPA, Ph.D., of
Christopher Newport University, Newport News, Va.
Their e-mail addresses, respectively, are
marc.lebow@hamptonu.edu, mcklaipm@inteliport.com
and wschell@cnu.edu.
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