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Global Tax Forum: U.N., Foreign-Government Employees Escape Some Tax Rules

Tracy Byrnes

Happy New Year! Judging from New Year's celebrations from Tonga to Hawaii, a glitch-free time was had by all.

The first Global Tax Forum of the new millennium will tackle a variety of reader questions, among them: What are filing requirements for gifts from nonresident aliens? What happens if you sell inherited overseas property? And how can an overseas U.S. citizen qualify for a Roth? In addition, did you know that United Nations workers get special tax treatment?

Ask your tax questions on the TSC Tax Forum board.

Read on to find out more!

Any other issues you'd like us to address? Send your questions to taxforum@thestreet.com. Please include your full name and resident country. Global Tax Forum appears every other Wednesday.

A U.N. Sleight of Hand

I would appreciate your advice on this issue as I have been getting conflicting information. I work for one of the United Nations agencies in New York. I have lived and worked in the U.S. for the last 15 years on a G-4 visa. I am not a U.S. citizen and I do not hold a green card. During the last three years, I have been trading quite a lot as an individual investor and have had some realized gains.

Are my capital gains/profits on my investments subject to U.S. tax? My salary is exempt from U.S. tax and, therefore, I do not have to file a tax return for my salary. However, every year I have reported all net gains, dividends and interest to the IRS on Form 1040NR, and I paid tax at a flat 30% without taking any deductions. Have I been doing the right thing?

-- Boon-Tiong Tay

Boon-Tiong,

Yes, it seems you have been doing the right thing.

Because you are an employee of a "foreign government or of an international organization," your wages are excluded from gross income as long as you are not a citizen of the U.S. or the Philippines, says Alicia Afalonis, an editor at the Research Institute of America, an information provider to tax professionals. (See Section 893 of the tax code for more details.)

Whether you are a resident or nonresident alien will determine whether or not you should pay tax on your capital gains. A nonresident alien doesn't pay capital gains tax. But you have lived in the U.S. for 15 years, so it would appear that you are a resident.

But things aren't always as they appear. Since you are a "foreign government-related individual" who is a "full-time employee of an international organization," you do not have to worry about the substantial presence test, according to 7701(b)(5)(B) . In its simplest form, the substantial presence test says that if you are in the U.S. for at least 183 days during the current year, you're taxed as a U.S. resident. (See the Internal Revenue Service's Publication 519 -- U.S. Tax Guide for Aliens for more details on this test.)

So for tax purposes, you really haven't been living full-time in the U.S. for the past 15 years. You're still considered a nonresident alien. Crazy, isn't it?

As a result, you appropriately are filing Form 1040NR - U.S. Nonresident Alien Income Tax Return, paying a 30% withholding tax only on your interest and dividends -- and not on capital gains.

Note that the minute you apply for permanent status in the U.S., all bets are off and everything becomes taxable (although I'm not sure why you'd ever give up this gig!).

Paperwork on a Big Overseas Gift

In a previous Global Tax Forum, reader Octavio Richetta asked whether a U.S. citizen must pay taxes on a gift from a nonresident alien. The answer: It is a nontaxable event, like any other gift.

But we want to highlight one important detail: That does not exclude you from a filing requirement.

If gifts from a nonresident alien total more than $100,000, a U.S. citizen must file Form 3520 - Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. That's just to let Uncle Sam know.

Even if the gift stays overseas, U.S. citizens still are required to file the form, says Michael Pfeifer, an Ernst & Young international tax partner in Washington.

And if you don't file the form, you'll get smacked with a failure-to-file penalty that can be as high as 25% of the amount you received, Pfeifer notes.

Inherited Property: Take Two

Would you expand on Annette Solyst's question in your Dec. 8 column about a nonresident alien inheriting foreign property. What are the tax consequences of selling the property?

-- Stefan Ordentlich

Stefan,

That column noted that there are no tax implications to inheriting property overseas. And if a nonresident alien sells overseas property, there are still no U.S. tax issues.

But if a resident alien sells his overseas property, he or she is taxed on the sale (if there's a gain), just like a U.S. citizen would be.

The gain on the property most likely will be taxed in the foreign locale as well, so be sure to check the country's tax treaty with the U.S. for potentially favorable treatment.

Overseas Citizen Wants a Roth

I am a U.S. citizen who has been working in Saudi Arabia for four years. I would like to know whether the foreign-earned income exclusion can be used in figuring out whether or not I meet the income levels to roll over existing IRAs into Roth IRAs and also with respect to establishing Roth IRAs.

-- Hardeep Dhindsa

Hardeep,

The foreign-earned income exclusion can disqualify you for a traditional or Roth IRA since it wipes out some of your earned income, says RIA's Afalonis. And remember, you need earned income to open an IRA.

As a U.S. citizen, you are taxed on your worldwide income. But the foreign-earned income, or FEI, exclusion allows you to exclude up to $74,000 of your foreign-earned income from your 1999 tax return, according to Section 911. (The exclusion jumps to $76,000 for your 2000 return.) FEI includes wages, salaries, professional fees, sick pay and vacation pay from sources in a foreign country. It doesn't include dividends, interest and capital gains.

But if you earned only $50,000, the credit would wipe it all out. Bottom line: You need to earn more than $74,000 to qualify for an IRA in the U.S.

If you do qualify, the IRA must be maintained by a U.S. bank or broker.