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U.S. IRS Practice Unit on Deferred Compensation Received by Nonresident Alien Individuals — Orbitax Tax News & Alerts

The U.S. IRS has published a practice unit on Deferred Compensation Received by Nonresident Alien Individuals. The general overview of the practice unit includes the following:

Generally, nonresident alien (NRA) individuals are taxed on effectively connected income (ECI) and U.S. source fixed or determinable, annual, or periodic (FDAP) income. ECI is earned from the operation of a U.S. trade or business, including from the performance of personal services in the United States, and is taxed at graduated rates on a net basis. FDAP income such as passive interest, dividends, rents, or royalties, is taxed at a flat 30% rate on a gross basis.

It is common for NRAs who perform personal services in the United States to receive compensation from an employer on a deferred basis. Deferred compensation is an agreement or arrangement under which a portion of compensation is paid out in a taxable year after the taxable year during which the income was earned. Deferred compensation can take many forms, including deferrals of salary or bonus until a subsequent year, tax-qualified retirement plans, "funded" and "unfunded" retirement arrangements, and stock option plans. A deferred compensation arrangement is "funded" when an employer transfers cash or other assets to a trust or pays a premium on an annuity contract for the exclusive benefit of an employee, resulting in a transfer to the employee of a beneficial interest in those assets that is beyond the reach of the employer's creditors. If, instead, the employee's interest is available to satisfy claims of the employer's general unsecured creditors in the event of bankruptcy or insolvency, the arrangement is "unfunded."

This practice unit discusses payments to NRAs from four types of deferred compensation plans:

  • Salary deferral – unfunded deferred compensation plans under which U.S. taxation is deferred until payment is made.
  • Distributions from a tax-qualified retirement plan (usually a pension or profit-sharing plan) of a U.S. company.
  • Payments made by a U.S. company under an unfunded "top hat" retirement plan for key employees.
  • Income arising under an equity-based compensation plan (employee stock option plan or restricted stock plan).

Unless specifically stated, the rules discussed in this practice unit apply to deferred compensation received by NRAs who were treated as employees, not independent contractors, during the period in which the deferred compensation was earned.

CAUTION: There may be deferred compensation arrangements other than the types discussed in this unit. Although there are many plans in which both employees and self-employed individuals may participate under the laws of the United States and of foreign countries, this practice unit addresses only a select number of issues that arise when NRAs receive some manner of deferred compensation from a U.S.-based multinational company, or from a tax-qualified retirement plan maintained by a U.S. parent company. For purposes of this unit, it is assumed that the employer is taking steps to ensure that the deferred compensation arrangement complies with the deferred compensation rules of IRC 409A if the plan is "unfunded," as well as the requirements of IRC 401 if the plan is "funded" and intended to be tax-qualified under U.S. law.

Click the following link for the International Practice Units page on the IRS website.