Many scientists who visit the United States for the purpose of engaging in research, training or studying are able to benefit from tax exemptions set forth in their home countries’ tax treaties with the U.S. Several countries have entered into bilateral tax treaties with the U.S., and many of those treaties contain provisions that create significant tax exemptions for income earned by researchers or trainees.
Each country’s tax treaty is slightly different, but a good example of a treaty provision that creates a tax exemption for some foreign scientists can be found in the U.S.-Spain tax treaty. Article 22(1)(a) of the treaty states:
The amounts referred to in subparagraph (a) of this paragraph are:
(i) payments from abroad, other than compensation for personal services, for the purposes of [an individual's] maintenance, education, study, research, or training;
(ii) the grant, allowance, or award [from a governmental, charitable, scientific, educational or other organization as set forth in Art. 22 (1)(a)(iii)]; and
(iii) income from personal services performed in that other Contracting State in an amount not in excess of 5,000 United States Dollars or its equivalent in Spanish pesetas for any taxable period.
In plain English, this means that Spanish researchers who come to the U.S. for the purpose of: (1) studying; (2) training; or (3) engaging in research (if that research is paid by a grant or fellowship from a government agency or not-for-profit institution); are entitled to an exemption from taxation for all or some of their income. The amount of the exemption is equal to: (a) the full extent of any payments made to the scientist from abroad for the purpose of her maintenance; (b) the full extent of the grant or fellowship she receives; or (c) $5,000 for any income based on personal services that is not covered by an exempt grant, fellowship or payments from abroad.
A word of caution: the U.S. Internal Revenue Service (IRS) frequently examines, or audits, individuals who claim treaty-based tax exemptions on their tax forms. IRS examiners often interpret the treaty provisions very narrowly. For example, IRS examiners sometimes take the position that Spanish researchers are only entitled to a $5,000 exemption, even if they receive a fellowship from a not-for-profit institution. This position is based on a common misunderstanding among IRS examiners, in which they assume that the $5,000 limitation on the exemption for personal services is also a limitation on the exemption for fellowship income. This interpretation is not supported by the language of the treaty, or by the IRS’s own interpretation as set forth in IRS Publication 901 regarding U.S. tax treaties. When confronted with legal arguments regarding the language of the treaty and IRS publications, IRS examiners often concede that the $5,000 limitation on the exemption for personal services does not apply to the exemption regarding fellowships.
W2 vs. 1042s
Exempt income should be reported by the hosting institution on IRS Form 1042s instead of on the scientist’s W2. Scientists should be careful to consult with their institution’s payroll department immediately if they believe that some or all of their income has been reported on the wrong form. IRS examiners generally give substantial weight to a hosting institution’s decision to report a scientist’s income on the W2 instead of 1042s, even though it is well known that these institutions (like other employers) often inadvertently misclassify their researchers’ income on tax forms. In many cases, the institution’s payroll department might make an honest mistake in determining that a researcher is not entitled to an exemption. These kinds of mistakes can cost a scientist dearly if the IRS denies the exemption on the sole basis that the fellowship income was reported on the scientist’s W2 instead of 1042s. Attorneys have successfully argued that fellowship income should be exempt even if it was misclassified on the scientist’s W2, but IRS examiners in some cases may demand that the hosting institution issue a formal correction in order for an exemption to be granted.
Get a Second Opinion
As discussed above, several countries’ tax treaties with the U.S. contain similar provisions, but each treaty is slightly different. Scientists should carefully review their country’s treaty and consult with an attorney or accountant if they are interested in exploring whether they qualify for the exemption. Even if a representative of the hosting institution’s payroll department argues that the scientist’s fellowship income is not exempt based on her home country’s tax treaty, she should consult with an outside professional if she believes she has a good faith argument for an exemption. If faced with an IRS examination, scientists should be sure to consult with an accountant or attorney who has direct experience dealing with tax exemptions for fellowship income, in order to avoid any missteps in responding to the audit.