Tax Planning for Nonresident Alien Artists

The independent contractor nonresident alien (NRA) who has a high level of U.S. tax-related operating expenses may wish to consider the feasibility of obtaining a Central Withholding Agreement (CWA) or otherwise be saddled with 30% tax withholding on his or her gross fees, with ultimate settlement of the actual tax liability only when an income tax return is filed. Obtaining a CWA can be an involved process requiring projected budgets of net earnings to obtain a reduced rate of withholding and must be done well in advance of the U.S. work. Whether the luxury of time before the work even exists is fundamental, but then there are the professional fees likely required to apply for the CWA and prepare all the foundational materials for such application.

Early Tax Filing

The NRA who will be an employee of a third party will have some of the same considerations, most notably the potential avoidance of Social Security and Medicare liability that would be done by eliminating the tax withholding via the bilateral agreement and obtaining the necessary proof from the foreign tax authority to supply to their U.S. employer. However, this withholding position will not be subject to the flat 30% rate of U.S. income tax. The NRA can only claim a filing status of 'Single' (whether married or not) with one Withholding Allowance on a Form W-4 and consequently will have income taxes withheld for both federal, as well as any applicable state purposes, at the rate such filing status provides (effectively at the highest possible rate). The result is that, typically, the NRA artist who is an employee can have significant tax refunds and will be best served in filing their returns as early as possible to obtain them.

One school of thought regarding early cycle filing is that it subjects the filer to a greater chance of being audited by the IRS. However, while possibly true of the general populace of filers, such a belief is probably meaningless for the NRA artist. This is because the IRS has formed a dedicated unit of examiners to focus on just NRA artists and athletes, which probably stems from the belief that there is a substantial amount of reportable revenue among such taxpayers that can be easily tracked and their business deductions challenged ' especially when the deductions are not the direct type (e.g., a commission paid on the earnings) but the indirect type (e.g., the appropriate amount of public relations to be allowed as a deduction against U.S. income, when income is earned throughout the world).

Another area of interest for the IRS concerns bifurcated agreements, where the work is undertaken both inside and outside the United States. Such agreements will be carefully scrutinized to satisfy the IRS that the portion of the work and related payments are fairly allocated.

The 'Green Card Test'

Also of great importance is the NRA artist's manner of entry into the United States. To work in the United States, the NRA requires an appropriate visa. However, many NRA artists learned years ago that obtaining a resident alien card (sometimes referred to as a 'green card' due to the green stripes on the original version of these cards issued in the 1950s) allowed them to come and go freely and avoid the necessity of obtaining a visa whenever new work arose. But obtaining such a card was far easier than it is today and why many NRAs did so.

Apparently, those advising these NRAs failed to mention the downside to having a resident alien card. Having one presumes the holder is a U.S. resident for tax purposes, which subjects the holder's worldwide income to U.S. taxation. This alone is a somewhat minor inconvenience, as the NRA who wishes to only pay tax in the United States on their U.S. income can overcome what is commonly known as 'the green card test' if there is an income tax treaty between the United States and the NRA's country of true residence.

The income tax treaties the United States has with its treaty partners have 'fiscal residence' articles within them, which are often referred to as tie-breaker provisions. The tie occurs when the United States deems the NRA its tax resident (e.g., due to the green card test), but the NRA is also deemed a tax resident of the other treaty country under that other treaty country's independent tax laws. To break the tie, the fiscal residence article looks to various factors that determine which country has the closer connection to the NRA. Generally, the green card test can be overcome through application of these tie-breaker provisions.

Yet, the fact that the NRA has a resident alien card will still present difficulties. One difficulty is that all employers dealing with the NRA who holds a resident alien card will presume he or she a U.S. tax resident and attempt to treat them as such, which generally results in incorrectly withheld income taxes of both the federal and state variety. Very careful attention must be paid to the initial payroll checks issued to the NRA who holds a resident alien card, to make certain the withholding wasn't incorrectly applied to the NRA as if a U.S. tax resident.

Very often, payments will have to be returned to employers and redrawn, or future payments will require adjustment to balance the initial withholding errors that were made. The reason the state income taxes are also often mistakenly withheld is that, if a NRA is seen as a U.S. tax resident, then the NRA must also be a tax resident of some state. It is fairly routine for payroll offices to make this dual error and treat the NRA as a resident of whatever state's address is on the NRA's payroll check, which is most often their talent agent's address, when the only state income taxes appropriately to be withheld are for the jurisdictions where the NRA works and that impose income taxes on nonresidents of the state.

Another potentially serious complication of having a resident alien card regards the requirement that the NRA holder of such a card is subject to the same financial disclosures of foreign financial assets as U.S. citizens. This issue has blindsided many NRAs, especially as overcoming the green card test for income tax purposes was widespread and it was taken for granted that doing so also avoided being subject to Foreign Bank and Financial Accounts, as well as Foreign Account and Tax Compliance Act reporting requirements.

Sadly, that is not the case. Obviously, the NRA artist with a resident alien card, but actually residing in another country, is likely to have extensive foreign financial assets that are subject to U.S. disclosure. Anyone familiar with the penalties for failing to disclose knows those penalties can be staggering. Accordingly, the NRA in possession of a resident alien card must be prepared to disclose all foreign financial assets subject to reporting, which can include bank and brokerage accounts, annuities, insurance policies, other direct and indirect investments, as well as trusts and ownership in partnerships and corporations organized outside the United States.

Athletes

Lastly, the most recent development that the NRA artist needs to be aware of is the recent line of cases the United States has brought against NRA athletes in order to tax at least a portion of their product endorsement income. The implications of those cases, brought by the United States against NRA golfers Retief Goosen and Sergio Garcia, could just as easily apply to artists depending on the requirements of their endorsement contracts. (See, Goosen v. Commissioner, 136 T.C. 547 (2011) and Garcia v. Commissioner, 13649-10 (T.C. 2013).) While the cases had somewhat different results, each case determined that a portion of the endorsement contract was allocable to the United States based on the personal services aspect of the agreements and thus should be used as guides in how the IRS might approach similar agreements for the product endorsements of the NRA artist.

Conclusion

Parts One and Two of this article aren't exhaustive analyses of all that may be encountered with the U.S. and related state taxation of a NRA artist. However, they make a fairly comprehensive start and should allow those representing such a person to have an awareness of the major issues they will need to understand and confront.

Andrew B. Blackman, CPA is a partner at Schulman Lobel Wolfson Zand Abruzzo Katzen & Blackman LLP (www.SchulmanLobel.com), which has offices in New York City and North Brunswick, NJ. A Certified Financial Planner, a Personal Financial Specialist, and Certified in Financial Forensics, he provides business management for performing and creative artists, athletes and other celebrities ' including nonresident aliens ' as well as tax and financial planning for high net-worth individuals and their closely held businesses. His predominant clientele have careers in screen, television, live stage and music, including several nominees and winners of Academy, Emmy and Tony Awards. He may be reached at [email protected].

The independent contractor nonresident alien (NRA) who has a high level of U.S. tax-related operating expenses may wish to consider the feasibility of obtaining a Central Withholding Agreement (CWA) or otherwise be saddled with 30% tax withholding on his or her gross fees, with ultimate settlement of the actual tax liability only when an income tax return is filed. Obtaining a CWA can be an involved process requiring projected budgets of net earnings to obtain a reduced rate of withholding and must be done well in advance of the U.S. work. Whether the luxury of time before the work even exists is fundamental, but then there are the professional fees likely required to apply for the CWA and prepare all the foundational materials for such application.

Early Tax Filing

The NRA who will be an employee of a third party will have some of the same considerations, most notably the potential avoidance of Social Security and Medicare liability that would be done by eliminating the tax withholding via the bilateral agreement and obtaining the necessary proof from the foreign tax authority to supply to their U.S. employer. However, this withholding position will not be subject to the flat 30% rate of U.S. income tax. The NRA can only claim a filing status of 'Single' (whether married or not) with one Withholding Allowance on a Form W-4 and consequently will have income taxes withheld for both federal, as well as any applicable state purposes, at the rate such filing status provides (effectively at the highest possible rate). The result is that, typically, the NRA artist who is an employee can have significant tax refunds and will be best served in filing their returns as early as possible to obtain them.

One school of thought regarding early cycle filing is that it subjects the filer to a greater chance of being audited by the IRS. However, while possibly true of the general populace of filers, such a belief is probably meaningless for the NRA artist. This is because the IRS has formed a dedicated unit of examiners to focus on just NRA artists and athletes, which probably stems from the belief that there is a substantial amount of reportable revenue among such taxpayers that can be easily tracked and their business deductions challenged ' especially when the deductions are not the direct type (e.g., a commission paid on the earnings) but the indirect type (e.g., the appropriate amount of public relations to be allowed as a deduction against U.S. income, when income is earned throughout the world).

Another area of interest for the IRS concerns bifurcated agreements, where the work is undertaken both inside and outside the United States. Such agreements will be carefully scrutinized to satisfy the IRS that the portion of the work and related payments are fairly allocated.

The 'Green Card Test'

Also of great importance is the NRA artist's manner of entry into the United States. To work in the United States, the NRA requires an appropriate visa. However, many NRA artists learned years ago that obtaining a resident alien card (sometimes referred to as a 'green card' due to the green stripes on the original version of these cards issued in the 1950s) allowed them to come and go freely and avoid the necessity of obtaining a visa whenever new work arose. But obtaining such a card was far easier than it is today and why many NRAs did so.

Apparently, those advising these NRAs failed to mention the downside to having a resident alien card. Having one presumes the holder is a U.S. resident for tax purposes, which subjects the holder's worldwide income to U.S. taxation. This alone is a somewhat minor inconvenience, as the NRA who wishes to only pay tax in the United States on their U.S. income can overcome what is commonly known as 'the green card test' if there is an income tax treaty between the United States and the NRA's country of true residence.

The income tax treaties the United States has with its treaty partners have 'fiscal residence' articles within them, which are often referred to as tie-breaker provisions. The tie occurs when the United States deems the NRA its tax resident (e.g., due to the green card test), but the NRA is also deemed a tax resident of the other treaty country under that other treaty country's independent tax laws. To break the tie, the fiscal residence article looks to various factors that determine which country has the closer connection to the NRA. Generally, the green card test can be overcome through application of these tie-breaker provisions.

Yet, the fact that the NRA has a resident alien card will still present difficulties. One difficulty is that all employers dealing with the NRA who holds a resident alien card will presume he or she a U.S. tax resident and attempt to treat them as such, which generally results in incorrectly withheld income taxes of both the federal and state variety. Very careful attention must be paid to the initial payroll checks issued to the NRA who holds a resident alien card, to make certain the withholding wasn't incorrectly applied to the NRA as if a U.S. tax resident.

Very often, payments will have to be returned to employers and redrawn, or future payments will require adjustment to balance the initial withholding errors that were made. The reason the state income taxes are also often mistakenly withheld is that, if a NRA is seen as a U.S. tax resident, then the NRA must also be a tax resident of some state. It is fairly routine for payroll offices to make this dual error and treat the NRA as a resident of whatever state's address is on the NRA's payroll check, which is most often their talent agent's address, when the only state income taxes appropriately to be withheld are for the jurisdictions where the NRA works and that impose income taxes on nonresidents of the state.

Another potentially serious complication of having a resident alien card regards the requirement that the NRA holder of such a card is subject to the same financial disclosures of foreign financial assets as U.S. citizens. This issue has blindsided many NRAs, especially as overcoming the green card test for income tax purposes was widespread and it was taken for granted that doing so also avoided being subject to Foreign Bank and Financial Accounts, as well as Foreign Account and Tax Compliance Act reporting requirements.

Sadly, that is not the case. Obviously, the NRA artist with a resident alien card, but actually residing in another country, is likely to have extensive foreign financial assets that are subject to U.S. disclosure. Anyone familiar with the penalties for failing to disclose knows those penalties can be staggering. Accordingly, the NRA in possession of a resident alien card must be prepared to disclose all foreign financial assets subject to reporting, which can include bank and brokerage accounts, annuities, insurance policies, other direct and indirect investments, as well as trusts and ownership in partnerships and corporations organized outside the United States.

Athletes

Lastly, the most recent development that the NRA artist needs to be aware of is the recent line of cases the United States has brought against NRA athletes in order to tax at least a portion of their product endorsement income. The implications of those cases, brought by the United States against NRA golfers Retief Goosen and Sergio Garcia, could just as easily apply to artists depending on the requirements of their endorsement contracts. ( See , Goosen v. Commissioner , 136 T.C. 547 (2011) and Garcia v. Commissioner, 13649-10 (T.C. 2013).) While the cases had somewhat different results, each case determined that a portion of the endorsement contract was allocable to the United States based on the personal services aspect of the agreements and thus should be used as guides in how the IRS might approach similar agreements for the product endorsements of the NRA artist.

Conclusion

Parts One and Two of this article aren't exhaustive analyses of all that may be encountered with the U.S. and related state taxation of a NRA artist. However, they make a fairly comprehensive start and should allow those representing such a person to have an awareness of the major issues they will need to understand and confront.

Andrew B. Blackman, CPA is a partner at Schulman Lobel Wolfson Zand Abruzzo Katzen & Blackman LLP (www.SchulmanLobel.com), which has offices in New York City and North Brunswick, NJ. A Certified Financial Planner, a Personal Financial Specialist, and Certified in Financial Forensics, he provides business management for performing and creative artists, athletes and other celebrities ' including nonresident aliens ' as well as tax and financial planning for high net-worth individuals and their closely held businesses. His predominant clientele have careers in screen, television, live stage and music, including several nominees and winners of Academy, Emmy and Tony Awards. He may be reached at [email protected].