WHY AM I BEING TAXED AS A RESIDENT, when I'm in the U.S. on an H-1B?” is a question many readers might ask themselves this tax season. This article attempts to shed light on this and other more obscure tax questions encountered by Indians who live and work in the U.S. on temporary work visas.

Even if you are not a U.S. citizen or a lawful permanent resident, you may be considered a resident for purposes of the Internal Revenue Service (IRS). The IRS, with its set of separate rules and definitions, applies a “substantial presence test” to determine who is a resident for tax purposes—if you are not a “resident”, then, you are a “nonresident.” Under the Substantial Presence Test, a foreign temporary worker must spend 183 days or more during the current year in the United States, or be physically present for at least •31 days during the current year and •183 days during the 3-year period, counting all the days during the current year, 1/3rd of the days present in the first preceding year, and 1/6th of the days in the second preceding year.

Example: Yashodan has an H-1B nonimmigrant visa, and his employer requires him to extensively travel between India and the U.S. on various work assignments. Yashodan first came to the U.S. in 2000, and after spending 120 days in the U.S., left on an assignment for India. He later returned to the U.S. for another 120 days in 2001, and again departed. In 2002, he returned to the U.S. for another 120 days. Under the Substantial Presence Test, Yashodan, having spent a total of 180 days in the U.S., is not considered a resident for tax purposes.

Even if Yashodan had spent 183 days (using the above day count rule) during the last three years in the U.S., i.e. met the Substantial Presence Test, he may still be treated as a nonresident if he meets all three factors of the Closer Connection to a Foreign Country Test. That test requires Yashodan to •be physically present in the U.S. for less than 183 days during the current year, •maintain a tax home in a foreign country, and •have a closer connection to his home country in which he has a tax home. A tax home is not necessarily a family home or an apartment as it may include a permanent place of business or employment. For Yashodan to establish that he has maintained more significant contacts with India than the U.S., he must show on IRS Form 8840, among other things, that his family, permanent home, and personal belongings are in India.

If you can establish either under the Substantial Presence Test or alternatively under the Closer Connection to a Foreign Country Test that you should be taxed as a nonresident, you are subject to U.S. income tax only on U.S. source income. Residents, as defined by the IRS, are taxed on income received world-wide.

If you have been in the U.S. for more than 183 days but less than one year, you may be considered a resident under the dual-status rule. A dual status year is one in which an individual's status changes between nonresident and resident, which can occur during the year of arrival to the U.S. You are treated as though your taxable year were comprised of two separate periods. For the part of the year you are a nonresident, you are taxed only on income from U.S. sources; for the part of the year when you are a resident, you are taxed on income from all sources, i.e., world-wide income. You should file both resident and nonresident tax forms (1040 and 1040-NR or 1040-NR EZ); clearly mark across the top of the resident form Dual-Status Return and mark across the top of the nonresident form Dual-Status Statement.

What if your Indian company sent you to a U.S. subsidiary to work and pays you your salary in India? Are you still responsible for paying U.S. taxes? Yes. All compensation for services performed in the U.S. is considered to be from a source in the U.S., and consequently, you must pay taxes on income received where you worked not where you were paid. Example: Vasumati is in the U.S. on an L-1 visa for the past year and has been receiving a U.S. base salary of $50,000. She was also paid $30,000 in India by her employer for services rendered in the U.S. Vasumati must pay U.S. income tax on the entire amount as she has performed all of his services in the U.S.

As part of her employment agreement, the company also provides a company car and a condo for Vasumati and her family. The company car may or may not be considered income and is taxable unless an exemption applies. If Vasumati cannot show that the car is used exclusively for company purposes, the use of the car will be considered a fringe benefit. A fringe benefit is a form of pay and is taxable income as it is provided by Vasumati's employer in exchange for her services. This is also true for the condo the company provided to Vasumati and her family. The condo is payment for services, and her employer must include it as reportable income on the Form W-2.

Dividends may or may not be considered income. To determine whether receipt of dividends is income depends on whether the dividends are received from a U.S. corporation, in which case the dividends are considered income and are taxable, or are received from a foreign corporation, in which case they are not taxable. Thus, dividend or interest income received from stocks, bonds, etc., is taxable as determined by the residence of the payer. Example: Yashodan owns stock in a company in India. He received a sizable dividend check from those stocks. The dividends received are not considered U.S. source and are not subject to U.S. taxation, assuming Yashodan is not a resident for tax purposes. Of course, if Yashodan were a resident under the IRS definition, it would be taxable, since residents are taxed on world-wide income.

Are U.S. residents required to pay taxes both in the U.S. and in India? For certain portions of their income paid to them in India which was subject to Indian taxes, a U.S. resident may be able to claim a Foreign Tax Credit. Failure to pay taxes not only subjects you to possible fines and, in severe cases, criminal penalties by the IRS but also precludes a finding of good moral character for purposes of applying for naturalization.

Those Indians who do not want to make the U.S. their permanent home and return to India should obtain a certificate of compliance, also known as a Sailing Permit. The Sailing or Departure Permit (Form 1040 - C or Form 2063) must be filed along with the income tax return before leaving. You should obtain a Sailing Permit at least 2 weeks before your scheduled departure. Contact the IRS office in your area of employment for assistance with these forms. Please note that this article is a general summarization of U.S. tax rules and should not be relied upon for any tax or estate planning. With the tax code growing in size and complexity, you should consult with a competent accountant or tax advisor about tax strategies and to determine if any exemptions are available to you.