U.S. Tax Considerations for International Medical Students and Physicians

The U.S. tax federal tax laws are the most complex body of law in the world. The tax laws and applicable tax treaty articles as they apply to foreign national students and scholars are among the most complex area of these tax laws. Whether or not a foreign national student is subject to U.S. tax laws depends on the nature of the payment, the resident status and any applicable treaty. Below is a general discussion of the tax implications for various situations and then the tax rules for particular temporary residence status in the United States.

Tax Implications

The U.S. tax implications of payments to individuals depends on the character of the payment, scholarship or fellowship or compensation for employment or self- employment.

• The character of a payment as a scholarship or fellowship is governed by the Internal Revenue Code (IRC) § 117 and the regulations thereunder. The designation of a payment as a scholarship or fellowship by the institution is not controlling.
• Payments designated as scholarships and fellowships that are paid for past, present or future services are compensation for services.
• Payments for teaching, research, or other services by the individual required as a condition of receiving the scholarship or fellowship are compensation for services.

Resident Aliens

Resident aliens are subject to tax on worldwide income. Nonresident aliens are subject to U.S. tax only on U.S. source income and income effectively connected to a U.S. trade or business. Therefore, the source of income of payments determines whether or not a payment to a nonresident is subject to U.S. tax.

Scholarship and fellowship payments paid by foreign sources or by international organizations are considered foreign source income. When such payments are made to nonresident aliens there is no U.S. tax implication. U.S. source scholarships and fellowships are subject to tax unless an exception applies.

1. Qualified scholarships under IRC § 117 that are paid to or on behalf of a candidate for a degree are excludable from gross income.
2. Qualified scholarships and fellowships include those amounts used to pay for tuition, fees, books, supplies, and required equipment.

In proposed regulations to IRC § 117 the IRS interprets "candidate for a degree" to include full- or part-time students not enrolled in a degree seeking program if the institution in which the student is enrolled:

• Offers an educational program that is acceptable for full credit toward a degree;
• Is authorized to offer such a program by federal or state law; and
• Is accredited by a national accreditation agency.

A scholarship or fellowship may be exempt from tax under an applicable tax treaty as "a grant, allowance or award".

The source of income for compensation for services is where the services are performed. Nonresident aliens who are paid for services performed in the U.S. are subject to U.S. tax unless an exception applies.

• Compensation for services paid by a foreign employer to an F-1, J-1 or Q-1 nonresident alien participating in an exchange or training program is exempt from tax under IRC § 872(b)(3).
• Compensation for services paid to a nonresident alien employee of a foreign government or international organization is exempt from tax under IRC § 893 if certain criteria are met.
• Compensation for services may be exempt from tax by an applicable tax treaty.

Character of Payment

The character of a payment as a scholarship or fellowship is also important in determining whether the payment is exempt as a "grant, allowance, or award" under an applicable tax treaty. Several Internal Revenue Service (IRS) rulings address the issue of the character of payments made to individuals by the National Institutes for Health (NIH).

1. Payments from the NIH Visiting Associates and Visiting Scientists Program are compensation for services and not exempt as "a grant, allowance or award." Rev. Rul. 87-40, 1987-1 C.B. 372.
2. Payments from the NIH Visiting Fellows Program are fellowship grants and exempt as "a grant, allowance or award" because visiting fellows are not expected to perform any services for NIH while participating in the program. Rev. Rul. 80-98, 1980-1 C.B. 368.

Whether payments to an individual are exempt from tax also depends on the individual's primary activity in the United States.

1. An individual's primary activity for treaty purposes can be determined with reference to the individual's U.S. immigration classification and documentation. The individual's primary activity is described in the application for a nonimmigrant visa such as an H-1B or in the category on the I- 20 form issued for the individual.
2. For example, an F-1 student's primary activity is studying even if the individual is employed as a teaching assistant. The tax treaty articles related to students would apply to this individual's activities, not the teacher/researcher article that requires that the primary purpose for the visit be teaching or engaging in research.

Temporary Residency Programs Tax Rules

The following temporary residency programs may be subect to the U.S. tax rules depending on the characterization of the payments made to individuals. Each one of these type of residencies will be discussed below for the tax rules that will be applicable.

• J-1 physicians in residencies sponsored by the Educational Commission for Foreign Medical Graduates (ECFMG);
• H-1B physicians in residencies;
• H-1B physicians practicing clinically;
• J-1 teachers and research scholars;
• TN physicians teaching or engaged in research;
• O-1 physicians practicing clinically; and
• F-1 medical students under practical training during their first year of internships (medical residencies).

For each type of residency program the tax rules are based on the individual's U.S. immigration status, primary activity and type of payment. Each of them will be analyzed under the following categories:

1. Resident alien vs. nonresident alien tax status
2. U.S. social security and Medicare tax applicability
3. Tax treaty exemptions from tax

Tax Rules for ECFMG J-1 Physicians in Residencies

Resident Alien vs. Nonresident Alien Tax Status

1. A J-1 physician is a nonstudent for purposes of the substantial presence test for determining tax residence.
2. A J-1 nonstudent who has not been in the U.S. on an F, J, M, or Q visa in the prior 6 years is a nonresident for the first two calendar years on the J-1 visa. The individual will be a resident in the third calendar year on the visa if the stay in the U.S. equals or exceeds 183 days in that calendar year.
3. A J-1 nonstudent who has been in the U.S. on an F, J, M, or Q visa in the prior 6 years will become a resident for tax purposes either in his first or second calendar year in the U.S. The determination is complex and depends on how many years the individual was in the U.S. in the prior 6 years ( 1 or 2 or more), whether he was an exempt individual when the individual was on such visas and the length or time the individual is in the U.S. on the current J-1 visa.
4. A J-1 individual who is a resident alien and who remains a tax resident of a treaty country may be able to show he is a nonresident of the U.S. under a treaty residency tie-breaker rule.

U.S. Social Security and Medicare Tax Applicability

1. J-1 nonresident aliens are exempt from U.S. social security and Medicare taxes.
2. J-1 resident aliens for tax purposes are subject to U.S. social security and Medicare taxes. The IRS requires that such taxes be withheld from January 1 of the calendar year in which the individual becomes a resident alien.

Tax Treaty Exemptions from Tax

1. To be eligible for a tax treaty exemption the individual must have been tax resident in a treaty country immediately before visiting the U.S. for the purposes of the visit. Some treaty articles require the individual to maintain tax residence in the treaty country in order to be eligible for treaty benefits. All dependent personal articles include this requirement.
2. J-1 physicians in residencies receive income from employment for training. Tax treaty exemptions under an applicable treaty depend on the tax treaty exemptions for employment income for trainees.

All treaties include an article (called dependent personal services) exempting employment income from tax.

• Most of the treaties limit the exemption to employment income paid by a resident of the treaty country or a nonresident of the U.S.
• The articles include a time limit, typically 183 days in the calendar year, in the U.S. for individuals claiming benefits. Exemption is lost if the time period is exceeded.
• A few treaties allow an exemption for small amounts of income paid to individuals from U.S. sources. Exemption is lost retroactively if the amount is exceeded. Most of these articles have a time limit as well. See for example Article XI of the treaty with Denmark.
• The treaty with Canada allows an exemption for $10,000 with no time period limitation during the year. The exemption is lost retroactively if the amount is exceeded.

Most treaties include a saving clause that allows the U.S. to tax its residents as if the treaty did not come into effect. See for example Article 23(1) of the treaty with Belgium. Individuals who become residents under the substantial presence test lose tax treaty exemptions for the year unless an exception applies.

• The saving clause for most treaties includes an exemption for benefits claimed under the student/trainee article. See Article 23(2) of the treaty with Belgium.
• No treaty includes a saving clause exception for exemption from tax under the dependent personal services article. An individual who is a resident alien loses benefits under the dependent personal services article unless he is a nonresident of the U.S. under the treaty tie-breaker rule.
• Some treaties include a saving clause that applies only to U.S. citizens and not to residents. See Article VII of the CIS/Former USSR treaty.

Tax Rules for H-1B Physicians in Residencies

Resident Alien vs. Nonresident Alien Tax Status

1. An individual on an H-1B is a resident alien in the first calendar year that the individual meets the 183-day substantial presence test. An individual who is in the U.S. on July 1 and stays in the U.S. through December 31 (184 days) is a resident.
2. An individual who enters on an H-1B after July 2 who has not been in the U.S. earlier in the year or in the U.S. in the two prior years (other than as an F, J, M, or Q exempt individual) is a nonresident in that year. He will be a resident in the next calendar year based on the formula. For example, the individual is in the U.S. no days in 1994, 120 days in 1995, and 160 days in 1996. The individual is a resident alien in 1996 based on the following formula:

• 1994 0 times 1/6 equals 0
• 1995 120 times 1/3 equals 40
• 1996 160 times 1 equals 160

U.S. social security and Medicare tax applicability - individuals in the U.S. in an H-1B immigration status are not exempt from U.S. social security and Medicare taxes.

Tax treaty exemptions from tax - the discussion above on treaty exemptions for J-1 Physicians in Residencies applies to H-1B Physicians in Residence as well.

Tax Rules for H-1B Physicians Practicing Clinically

1. Resident alien vs. nonresident alien tax status - The discussion above on resident status for H-1B Physicians in Residencies applies as well to H-1B Physicians Practicing Clinically.
2. U.S. social security and Medicare tax applicability - individuals in the U.S. in an H-1B immigration status are not exempt from U.S. social security and Medicare taxes.
3. Tax treaty exemptions from tax

Tax Rules for J-1 Teachers and Research Scholars

Resident alien vs. nonresident alien tax status - The discussion above on resident status for J-1 Physicians in Residencies applies to J-1 Teachers and Research Scholars as well.

U.S. Social Security and Medicare Tax Applicability

• J-1 nonresident aliens are exempt from U.S. social security and Medicare taxes.
• J-1 resident aliens for tax purposes are subject to U.S. social security and Medicare taxes. The IRS requires that such taxes be withheld from January 1 of the calendar year in which the individual becomes a resident alien.

Tax Treaty Exemptions from Tax

To be eligible for a tax treaty exemption the individual must have been tax resident in a treaty country immediately before visiting the U.S. for the purpose of the visit. Some treaty articles require the individual to maintain tax residence in the treaty country in order to be eligible for treaty benefits. All dependent personal articles include this requirement.

Many, but not all, treaties include an article for professors and teachers that includes exemption from tax from compensation for both teaching and engaging in research.

• Exemption is limited to research performed for the public benefit.
• Article limitations are typically for 2 years without a limit on the amount.
  • The limit for Article 19 under the treaty with China that covers researchers is 3 years in the aggregate.
  • A number of treaties include a maximum combined 5 year limit with the student/trainee article that can result in shortening the teacher/researcher treaty period. See Article 21(4) of the treaty with Belgium.

To be eligible under these articles the teaching or research must typically be conducted at an educational institution. An educational institution is an organization that "normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on." Treas. Reg. § 1.117-3(b).

1. The IRS determined that a university hospital that had many administrative and functional ties to a university but was a separate corporation controlled by its own board of trustees and which maintained no regular faculty and curriculum and had no organized body of students was not an educational institution. Rev. Rul. 77-175, 1977-1 C.B. 415.
2. In another ruling the IRS determined that a research fellow appointed to the faculty of a university medical school who conducted research at a laboratory at a hospital associated with the school was exempt from tax even though his compensation was paid by the hospital. The individual was performing the research under the supervision and control of the medical school. Rev. Rul. 81-79, 1981-1 C.B. 605.

Some treaties include, in addition to educational institutions, other types of institutions in the teacher/researcher articles such as research institutions (France, Article 20), scientific research institutions (China, Article 19 and the CIS/Former USSR treaty, Article VI,1(c)(1)), medical facilities primarily funded from government resources (Italy, Article 20), and institutions engaged in research for the public benefit (Germany, Article 20).

An individual engaged in research who is the recipient of a grant, allowance, or award from a charitable organization may be exempt from tax under the student/trainee article of a treaty. See for example Article 21(a)(1)(iii) of the treaty with Belgium.

The individual may be exempt from tax on both the grant and on a limited amount of compensation for services.

These types of articles do not define the type of institution at which the research is to be conducted.

An individual who becomes a resident alien may nevertheless qualify for treaty benefits if the treaty saving clause allows an exception for benefits conferred under the teacher/researcher and student/trainee articles or if the saving clause applies only to U.S. citizens and not to residents. See Article VII of the CIS/Former USSR treaty.

The discussion above on tax treaty exemption for employment income also applies to J-1 teachers and researchers.

Tax Rules for TN Physicians Teaching or Engaged in Research

1. Resident alien vs. nonresident alien tax status - The discussion above on resident status for H-1B Physicians in Residencies applies to TN teachers and researchers also.
2. U.S. social security and Medicare tax applicability - individuals in the U.S. in an H-1B immigration status are not exempt from U.S. social security and Medicare taxes.
3. Tax treaty exemptions from tax - The discussion above on tax treaty exemptions for J-1 Teachers and Research Scholars applies to TN teachers and researchers also.

Tax Rules for O-1 Physicians Practicing Clinically

1. Resident alien vs. nonresident alien tax status - The discussion above on resident status for H-1B Physicians in Residence applies to O-1 physicians also.
2. U.S. social security and Medicare tax applicability - individuals in the U.S. in an O-1 immigration status are not exempt from U.S. social security and Medicare taxes.
3. Tax treaty exemptions from tax - The discussion above on tax treaty exemptions for H-1B Physicians Practicing Clinically applies to O-1 physicians as well.

Tax Rules for F-1 Students Engaged in Practical Training for First Year Medical Residency Internships

Resident Alien vs. Nonresident Alien Tax Status

1. An F-1 student who has not been in the U.S. on an F, J, M, or Q visa in any of 5 calendar years or more since 1985 is a nonresident for the calendar year.
2. Otherwise the F-1 student is a resident alien unless he proves that he is not intending to remain permanently in the United States by showing a closer connection to a foreign country and a specific intention to return home.
3. An F-1 student who is a resident alien and who remains a tax resident of a treaty country may be able to show he is a nonresident of the U.S. under a treaty residency tie-breaker rule.
   • Treaty tie-breaker criteria typically consider permanent home, center of vital economic interests, habitual abode, and nationality.
   • A person's permanent home is where he resides with his family. Therefore, if the individual is accompanied to the U.S. by a spouse and/or children his permanent home is the U.S.
   • Nonresident status under a treaty tie-breaker rule applies to income taxes only. An individual who is a resident is nevertheless subject to social security and Medicare taxes.

U.S. Social Security and Medicare Tax Applicability

• F-1 nonresident aliens are exempt from U.S. social security and Medicare taxes.
• F-1 resident aliens are subject to U.S. social security taxes. The IRS requires that such taxes be withheld from January 1 of the calendar year in which the individual becomes a resident alien.

Tax Treaty Exemptions

The primary activity for an F-1 student under practical training is training. The discussion above on tax treaty exemptions for J-1 Physicians in Residence applies to F-1 students engaged in practical training during their first year of medical residencies also.

Summary

As you can see the tax status for temporary residency can be quite complicated. The analysis of whether the foreign national is subject to U.S. tax law begins with the status of their residency in the United States, the nature of the payment they receive, and whether there are any treaty exemptions. Working through each one of the elements should provide the necessary answers, but if not, information is available from the IRS or from the individuals school or employer. If that is still not satisfactory an attorney specializing in tax or immigrant law should be consulted.