On June 14, 2016, the IRS released their newest Practice Unit, outlining guidance on the payment of grants or scholarships to Nonresident Aliens, or “NRAs.” This Practice Unit covered some important points for understanding the taxability of payments to student NRAs. A “Practice Unit” is not an official pronouncement of law or directive and cannot be used, cited or relied upon as such. A Practice Unit is a general discussion of a concern, process or transaction and provides a means for collaborating and sharing knowledge among IRS employees.
Under Internal Revenue Code § 117, if a payment, grant, or scholarship meets the following three tests, it can be excluded from taxable gross income and is not subject to U.S. federal income tax withholding. Also, if the requirements are met, the amount does not need to be reported on Forms 1042-S and 1040/1040NR.
- The scholarship must be for “qualified expenses” such as tuition, required fees, and required books and supplies.
- The NRA student is seeking a degree or is studying at an institution that provides degrees and that institution is properly accredited
- The institution is an educational organization that satisfies the requirements under IRC Section 170(b)(1)(A)(ii).
If not all of these requirements are met, the NRA student may be eligible for relief from tax withholding under an income tax treaty. The U.S. has tax treaties with a number of foreign countries that could provide relief from U.S. tax withholding on U.S. income received by foreign citizens.
Non-qualified scholarship amounts, such as payments that are used toward room and board, may be subject to a U.S. federal income tax withholding rate of 30% or 14% unless exempt by a treaty. Other examples of non-qualified expenses are meals, travel, medical costs, and non-required books and supplies.
Some questions to consider when determining the tax treatment of payments include:
- What is the NRA’s country of residence? The NRA’s resident country may have an applicable treaty.
- Why is the NRA residing the U.S.? An NRA may be eligible for treaty benefits if he or she is residing in the U.S. as a student.
- What is the award/payment for? The payment must meet treaty requirements (specific to each country) in order to be considered eligible for treaty relief.
Factors determining a NRA’s eligibility are different in each treaty. Other common factors include but are not limited to the following: the reason for the NRA’s visit, the amount of time the NRA is spending in the U.S., or the dollar amount associated with the U.S. source payment.