QuickBooks Payroll Bulletin | December 2006

Calculating Federal Withholding for Nonresident Aliens

A new procedure to calculate federal withholding for nonresident aliens went into effect Jan. 1, 2006. Starting Jan. 1, 2007, the IRS may assert interest and penalties on employers for underpayments of income tax withholding resulting from failure to apply the new withholding procedures for nonresident alien employees.

Understanding the Calculations

Under the current withholding procedure, an employer will add an amount based on the chart in IRS Publication 15 (Rev. January 2006) on page 15 to the wages of the nonresident alien employee solely for purposes of calculating the federal income tax to be withheld for each payroll period. The amount added to the wages is not income or wages to the employee; it does not affect income, FUTA, Social Security, or Medicare tax liability for the employer or the employee; and it is not to be reported as income or wages.

The additional wage amount is based on the employee's pay frequency and is added to their income, taxed, and then deducted. Because the additional amount is deducted, it does not appear on the employee's W-2.

Example: John is a nonresident alien employee subject to federal income tax withholding. He is paid $500 per week. Because of his nonresident alien employee status, he needs to be taxed on $551 weekly. The extra $51 is calculated based on the chart in IRS Publication 15 (Rev. January 2006) on page 15 and is also outlined in the Setting Up the Procedure section below.

While creating the nonresident alien employee's paycheck, a taxable payroll item is created to accomplish the extra taxation. Then, that taxable payroll item is removed, and the employee's federal income tax amount is adjusted manually on the paycheck. The result is that John is taxed on the extra $51, but not paid an extra $51.

Important:

• This procedure only applies to nonresident alien employees who have wages subject to federal income tax withholding.
• This procedure for determining the amount of federal income tax withholding does not apply to a supplemental wage payment if the 35% mandatory flat rate withholding applies or if the 25% flat rate withholding is being used to calculate federal income tax withholding on the supplemental wage payment (see IRS Publication 15, Circular E, Revision 2006, page 15).

Setting Up the Procedure

1. The first step is to determine if the employee qualifies as a nonresident alien subject to federal income tax withholding.

   The government has very detailed qualifiers to be a nonresident alien. Refer to IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities and Publication 519, U.S. Tax Guide for Aliens if you have questions. IRS Publication 519 provides the qualifications to be determined as a nonresident alien on pages 4-11. You may also want to contact your accountant or tax professional.

   Useful IRS Publications:

   • IRS Publication 15 (Circular E), Revision January 2006
   • IRS Publication 515, Revision January 2006
2. An employee who qualifies as a nonresident alien and is subject to federal income tax withholding will have a new way of completing the IRS Form W-4. Per IRS requirements, when a nonresident alien completes a Form W-4, they are required to:
   • Not claim exemption from income tax withholding
   • Request withholding as if they are single, regardless of their actual marital status
   • Claim only one allowance (if the nonresident alien is a resident of Canada, Mexico, or Korea, they may claim more than one allowance)
   • Write "Nonresident Alien" or "NRA" above the dotted line on line 6 of Form W-4

   Note: Nonresident alien students from India and business apprentices from India are not subject to this procedure.

3. If the employee qualifies as a nonresident alien and has indicated on Form W-4 "Nonresident Alien," proceed with the following steps in QuickBooks.

In QuickBooks:

1. In QuickBooks 2007: Select Manage Payroll Items, and then choose New Payroll Item.
   In QuickBooks 2004-2006: From the Employees Menu, select Payroll Item List.
2. Select Payroll Item, then click New.
3. Create a Custom Payroll Item by selecting Custom Setup, then click Next.
4. Select Addition, and then click Next.

5. Enter the name used in paychecks and payroll reports as "Nonresident alien - biweekly" (or the payroll period that the business uses). Then click Next.

   Note: Employers would want to add a payroll item for each type of payroll period they have.

6. Select the Payroll Expense account for tracking the expense. Then click Next.
7. Select the tax tracking type Compensation, click Next.
8. Leave the default settings on Taxes, click Next twice.
9. At the "Default rate and limit" screen, enter the additional amount in the first box for the payroll period from the IRS Nonresident Alien chart in Publication 15 on page 15. (The chart is also reproduced below.) Remove the check mark in the "This is an annual limit" box. Click Finish.

Chart is reproduced from IRS Publication 15 (Rev. January 2006) page 15.

The amounts added under this chart are added to wages solely for calculating income tax withholding on the wages of the nonresident alien employee. These chart amounts should not be included in any box on the employee's Form W-2 and do not increase the income tax liability of the employee. Also, these chart amounts do not increase the Social Security, Medicare, or FUTA tax liability of the employer or the employee.

This procedure only applies to nonresident alien employees who have wages subject to income tax withholding.

Paying the Employee(s)

To pay the employee(s) in QuickBooks:

1. Select the choice to pay the employee and view the paycheck before creating.
2. In the Other Payroll Items section, select the appropriate "Nonresident alien-xxx" payroll item. (This selection will then add the amount to the employee's wages and recalculate all their taxes.)
   From this screen, write down the amount of federal withholding taxes from the Employee Summary. This amount is needed for step 4.
3. Delete the "Nonresident alien-xxx" item from the Other Payroll Items, and the check recalculates back to its original calculations (same as step 1).
4. Highlight the federal withholding amount under the Amount column in the Employee Summary section and change it to the amount calculated in step 2. (This is the amount that was written down for the entry to be used in step 4.)

The final result reflects the correct amount of federal withholding taxes for the nonresident alien for that paycheck as well as their YTD amount.

The information contained in the QuickBooks Payroll Bulletin is meant to provide general information about the payroll process and is not intended to provide tax or legal advice. Always consult your tax professional when preparing tax documents.