Taxation of Dual-Status Aliens

Taxation for Dual Status Aliens

Resident and nonresident aliens worry about the complexities of their tax filing requirements. However, these U.S. aliens can usually refer to the guidelines of their respective residential status and easily fulfill their filing obligations. This is not the case for individuals who are both residents and nonresidents of the United States or dual-status aliens.

A Dual-status alien is taxed separately for the period he was a resident and for the period he was a nonresident. In general, according to Code Sec. 871 and Reg. §1.871-1, a resident alien is taxed on income derived from all sources, even those that are from outside the United States. On the contrary, a nonresident alien is only taxed on income derived from the United States and certain foreign income that is effectively connected with a trade or business in the United States. For example, this means that if you received interest income while a nonresident from an Australian bank that is not effectively connected with a trade or business in the United States, you are not required to report that interest income in filing your U.S. taxes.

However, in regards to determining taxable income for dual-status aliens, it is important to consider exemptions provided by the Internal Revenue Code and the provisions between the United States and the tax treaty country. As an example, even though interest income from a U.S. bank that is not effectively connected with a U.S. trade or business is normally taxable for nonresidents at a flat rate of 30% or the lower treaty rate, it is exempt from taxation per the Internal Revenue Code.

The form you are required to file depends on whether you are a resident alien or a nonresident alien at the end of the tax year. According to Publication 519, U.S. Tax Guides for Aliens, you must file Form 1040 if you are a dual-status alien who is considered a resident on the last day of the tax year. In this case, you are required to write “Dual-Status Return” across the top of the Form 1040 and attach a statement that shows your income for the part of the year you are a nonresident. Such statements must include your name, address, and taxpayer identification number. For the purposes of filing the nonresident statement, Form 1040NR or Form 1040NR-EZ can be used, but the words “Dual-Status Statement” must be written across the top of the form. The same procedure applies if you are considered a nonresident at last day of the tax year, except that now Form 1040NR or Form 1040NR-EZ is the main return and Form 1040 is the statement for the part of the year you are a resident.

Unfortunately, filing as a dual-status alien subjects you to various restrictions:

  1. Standard Deduction – you can itemize deductions but you are not allowed to take the standard deduction.
  2. Head of Household – you cannot use the head of household filing status.
  3. Exemptions – for the part of the year you are a resident you can take exemptions for your spouse and dependents, but limited to your taxable income (figured without deducting personal exemptions). However, for the part of the year you are a nonresident, there are special rules if you are also a resident of Mexico, Canada, or South Korea. These special rules also apply if you are a student or business apprentice from India or a U.S. national.
  4. Joint Return – You cannot file a joint return if you are a nonresident unless you are married to a U.S. citizen or a resident alien and you choose to file jointly (MFJ). If you are married to a U.S. citizen or a resident alien and you do not choose to file jointly, you must file Married Filing Separately. You cannot take advantage of the lower tax rate for MFJ and Single taxpayers.

In spite of the above restrictions, dual-status aliens are still entitled to certain credits that apply to resident aliens. These credits include the Foreign Tax Credit, Retirement Savings Contributions Credit, Adoption Credit, Child and Dependent Care Credit, and the Child Tax Credit.

Please note that the Child and Dependent Care Credit as well as the Adoption Credit cannot be claimed by a married dual-status alien unless he chooses to file a joint return with his U.S. citizen or resident alien spouse. The same provision applies to the Education Credits, Credit for the Elderly or Disabled, and the Earned Income Credit.

It is important for foreigners to be familiar with the taxation of dual-status aliens before deciding to live in the United States, or in the case of U.S. residents, before deciding to move to a foreign country. Knowing the filing requirement for dual-status aliens will help U.S. aliens plan ahead in regards to their investments or other sources of income. This will help avoid future problems with the IRS and even the U.S. immigration itself should the U.S. alien consider becoming a citizen of the United States in the future.

 

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