The Structure of US Taxation on Individuals

There are three factors to determine how an individual's income is subject to US income taxes:

1. Status - resident or non-resident
2. Source of income
3. Whether or not connected to US trade or business

US citizens and residents (based on "green card" or "substantial presence" tests, see flowchart 2.) are taxed on their worldwide income. US citizens or permanent resident who establish a foreign tax home and meet certain qualifications can elect to exclude annual foreign earned income up to $80,000 from taxable income in 2002. Except for the exclusion, both foreign and US source of income are subject to US income tax. To reduce double tax, taxpayer may elect to take a foreign tax credit or foreign tax deduction on taxes paid to foreign government.

Non-resident aliens are taxed on their US source income only.

1. If they do not engage in business in the US and their only income is fixed determinable annual or periodical income (FDPI) such as interest, dividends, royalties, and rents, the FDPI income will be taxed at a flat rate of 30% (or a lower flat rate by a tax treaty). The 30% tax will be withheld at sources. These non-residents do not have to file income tax return if taxes are properly withheld on their FDPI income.

2. If non-resident aliens engage in business in the US, they must file a tax return (Form 1040NR), and any income connected to the US trade or business is subject to a progressive tax similar to that on US resident. The major difference between filing F1040 and F1040NR are: non-resident aliens who file 1040RN generally cannot claim exemption for their spouses or dependent children. (With certain exceptions for residents of Canada, Mexico, Japan and Republic of Korea) Moreover, non-resident alien do not have standard deduction.

See Flowchart 1 for illustration of the structure of US tax on individuals.

Factors to Determine the Income Subject to US Income Tax

1. Status - resident or non-resident
2. Source of income
3. Whether or not connected to US trade or business