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Withholding Requirements for Scholarships to Foreign Students

December 01, 2010

Elizabeth A. Solecki, CPA
Tax Director
BlumShapiro

Resident Alien vs. Nonresident Alien

A foreign student is considered either a resident alien or a nonresident alien.  A resident alien is an individual who is not a citizen or a national of the U.S. and who meets either the green card test or the substantial presence test for the calendar year, defined as follows:

  • Green card test – An alien is a U.S. resident if the individual was a lawful permanent U.S. resident at any time during the year (i.e. actually holds a green card).
     
  • Substantial presence test - An alien is a U.S resident if the individual meets the substantial presence test for the calendar year.  Under the test, the individual must be physically present in the U.S. on at least 31 days during the current calendar year and 183 days in total during the current year and the two preceding years.

For the substantial presence test, the days that a person is an "exempt individual" are not counted as days of presence in the U.S.  A student who is temporarily present in the U.S. under an "F," "J," "M" or "Q" visa is considered an exempt individual.  This exception is for a limited period of time.  A person will not be considered an exempt individual as a teacher, trainee or student for any part of more than five calendar years unless the person does not intend to reside permanently in the U.S., and has substantially complied with the visa requirement.

Resident aliens are treated as U.S. citizens for tax purposes; therefore, there is no withholding requirement on taxable scholarships to resident aliens.

A nonresident alien is an individual who is not a U.S. citizen or a resident alien. It is likely that most students staying in the U.S. just to attend school will not meet the green card test or the substantial presence test, and will be treated as nonresident aliens.

Taxable Scholarship vs. Nontaxable Scholarship

A scholarship is excludable from taxable income only if the recipient is a candidate for a degree at an eligible educational institution, and the scholarship is used to pay for "qualified education expenses."  These are tuition and fees required to enroll at or attend an eligible educational institution, and expenses required for the courses at the eligible educational institution. 

Qualified education expenses do not include the cost of room and board, travel, equipment or other expenses not required for enrollment, and scholarships used to pay any expense that is not a qualified education expense are taxable. 

Withholding Requirements for Nonresident Aliens

While there are no withholding requirements on taxable or nontaxable scholarships to resident aliens or on nontaxable scholarships to nonresident alien candidates for a degree, withholding is required on taxable scholarships (scholarships not used for qualified education expenses, i.e. room and board, travel) to nonresident aliens.  Withholding is at 14% of the taxable scholarship amount, but it may be reduced to a lesser amount (or 0%) depending on the tax treaty between the U.S. and the student's country.  All taxable scholarships must be reported to the IRS on Forms 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and 1042-S, Foreign Person's U.S. Source Income Subject to Withholding.

In order for the withholding rate to be reduced below 14%, the student must provide the school with Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding. The school maintains the Form W-8BEN in its records, and the form is valid for three years. If this form does not contain a valid Taxpayer Identification Number (TIN), it cannot be accepted by the school as a valid withholding certificate for the purpose of claiming a tax treaty benefit. Therefore, the student must have a TIN in order to complete Form W-8BEN – otherwise the school must withhold at the 14% rate.

Form 1040NR Filing Requirements

A student who receives scholarship income and is temporarily in the U.S. under an "F," "J," "M," or "Q" visa is treated as a nonresident alien engaged in a U.S. trade or business and required to file Form 1040NR, U.S. Nonresident Alien Income Tax Return.  They must do this even if they have no income from a trade or business conducted in the U.S., have no U.S. source income or that income is exempt from U.S. tax under a treaty or any section of the Internal Revenue Code.

In addition, a TIN is required on Form 1040NR. Form W-7, Application for IRS Individual Taxpayer Identification Number, must be completed to apply for a TIN.  Form W-7 must be accompanied by the required supporting documentation.

 

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