It’s an area of which many may not be aware right now, but educational institutions may need to withhold tax on scholarship payments to foreign students.
It’s an area of which many may not be aware right now, but educational institutions may need to withhold tax on scholarship payments to foreign students. Additionally, certain scholarship payments may have a reduced withholding tax rate, while others are exempt from withholding.
Generally, a foreign person not engaged in a trade or business in the United States is not required to file a U.S. income tax return if a withholding agent withholds the tax liability at the source. However, scholarships received may be viewed as a U.S. source payment, and therefore may be subject to U.S. withholding tax depending on what items the scholarship covers. In most cases, a withholding agent must withhold a flat 30% tax on items of U.S. income paid to a foreign person that are U.S.-sourced and fixed, determinable, annual or periodic (“FDAP”). Lower withholding rates may apply to scholarship payments made to individuals with “F,” “J,” “M” or “Q” nonimmigrant student status, whereas higher rates apply to any other foreign person with any other immigration status.
Academic institutions are considered withholding agents when it comes to providing financial aid to foreign students—such as scholarships, grants, fellowships and assistantships. For the foreign person, U.S.-sourced financial aid payment received is considered source income, so it may be subject to withholding by the academic institution, and failure to withhold could result in the imposition of penalties and interest to the withholding agent.
Generally, with qualified scholarships—for tuition, fees, books, supplies and equipment—payments to foreign students who are degree candidates are exempt from withholding. However, nonqualified scholarship payments (i.e. room, board, travel, living expenses) are subject to a 14% withholding tax rate. Even if the scholarship or grant is earmarked for room or board, and the proceeds are used for tuition, the payment is still subject to the 14% withholding. Any other scholarship payment made to a foreign person under immigration status other than “F,” “J,” “M” or “Q” nonimmigrant status, is subject to the 30% tax withholding.
Some scholarship or grant payments require the foreign person to study and work, so a portion of the payment consists of financial aid and the other is considered wages. The financial aid portion may be exempted or subject to 14% withholding, whereas the wage portion is subject to graduated withholding rates.
Income tax treaty provisions sometimes exempt tax withholding on entire payments regardless of whether the scholarship or grant is qualified under U.S. law. Treaty provisions override U.S. law and state law provisions on tax withholding. Usually, an income tax treaty provides a withholding exemption or partial exemption on scholarships, grants and other payments made to a foreign student.
An agent is required to withhold tax on payments to a foreign student, unless there is a withholding exemption provided via the treaty benefit. This exemption should be claimed by the student submitting the proper form to the withholding agent; similarly, if the student receives partial scholarship and wages, he or she may also claim treaty exemption withholding benefits on wages by submitting the appropriate form.
Even when income tax treaties are used to reduce the withholding tax to 0%, the annual compliance forms are still required.
Failing to pay federal taxes withheld can result in a penalty of 100% of the amount not paid. This may be assessed against anyone responsible for the funds from which payment of withheld tax could have been made. What’s more, paying withheld federal taxes late may result in penalties up to 10%, plus interest, on the balance paid late. State penalties vary, and failure to file withholding tax forms in a timely manner may result in penalties up to $50 per form not filed. However, intentional or willful failure to withhold taxes on scholarships or grants may result in criminal penalties.
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