Canadian's Ohio unemployment compensation is taxable

Unemployment compensation received by a Canadian citizen from Ohio is subject to U.S. tax under treaty.
By Charles J. Reichert, CPA

The Tax Court held that a Canadian citizen must pay U.S. income tax on unemployment compensation received from the state of Ohio. According to the court, an exemption claimed by the taxpayer under the tax treaty between the United States and Canada for salaries, wages, or "similar remuneration" was inapplicable.

Facts: Pei Fang Guo, a Canadian citizen and a nonresident alien of the United States, was employed by the University of Cincinnati from October 2010 until Nov. 30, 2011. In 2012, while she resided in Canada and was present in the United States for only two days, she received unemployment benefits of $15,972 from the Ohio Department of Job and Family Services. For tax year 2012, she completed Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents. She reported the unemployment compensation on Schedule OI, "Other Information," indicating the amount was exempt from U.S. tax under the U.S.—Canada tax treaty. On her 2012 Canadian return, Guo reported the unemployment compensation as income. The IRS, contending that the benefits were taxable to the United States, sent her a deficiency notice of $1,391 for 2012. The taxpayer petitioned the Tax Court for relief.

Issues: Nonresident aliens, persons who are not a resident or citizen of the United States, pay U.S. income tax on their U.S.-source income. Income that is effectively connected with a U.S. trade or business is taxed at the same rates as that of U.S. citizens, while income that is not effectively connected with a U.S. trade or business is taxed at 30%, unless a tax treaty has specified a lower rate. A tax treaty between the United States and another country can exempt certain income from U.S. tax.

The U.S.—Canada tax treaty makes one reference to unemployment compensation: Under the treaty, it is not considered social security benefits. Article XV of the treaty exempts the salaries, wages, and "other similar remuneration ... in respect of an employment" of a Canadian nonresident alien from U.S. income tax. It allows Canada rather than the United States to tax remuneration if (1) its amount is not more than $10,000 (in U.S. dollars), or (2) the Canadian nonresident alien was present in the United States for less than 184 days during the tax year and the remuneration was not borne by an employer who is a U.S. resident. Article XXII of the treaty allows the United States to tax any income arising in the United States that is not covered in other articles of the treaty. The taxpayer argued that the unemployment compensation was exempt from U.S. tax under Article XV because it was derived in respect of an employment, while the IRS argued that it was taxable under Article XXII.

Holding: The court rejected the taxpayer's argument, holding that Article XV was not applicable because unemployment compensation is not remuneration derived in respect of an employment. Because the treaty does not define "remuneration," the court applied the meaning from Sec. 3401, which provides for withholding income tax from wages, and Sec. 3121, which defines income subject to Federal Insurance Contributions Act tax withholding. Noting that both Code provisions define "remuneration" in terms of wages for employment, the court reasoned that just as unemployment compensation does not constitute wages or salaries, it did not constitute "similar remuneration."

It added that even if unemployment compensation were remuneration, Article XV was still inapplicable because the amount paid to the taxpayer was more than $10,000 and it was borne by a U.S. resident, the Ohio Department of Job and Family Services. Because the tax treatment of unemployment compensation is not addressed in the treaty, the court held that Article XXII applied and that the unemployment compensation was taxable by the United States, since it arose there.

Because the unemployment compensation was taxed by Canada, the taxpayer argued that if she had to pay U.S. tax on it, she would be subject to double taxation, something that the treaty states in paragraph 1 of Article XXIV should be avoided in the case of a U.S. citizen or resident, by the allowance of a credit against the taxpayer's U.S. tax for any Canadian income tax paid. However, because the taxpayer was not a U.S. citizen or resident, the court found that paragraph 1 did not apply to her. Paragraph 2(a) of Article XXIV provides similar relief from Canadian tax for U.S. income tax paid; however, according to the court, it had no jurisdiction under the treaty to grant this relief because it should be granted by Canada, not the United States.

  • Guo, 149 T.C. No. 14

—By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.

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