TAX INSIDER

Researchers and scholars claim tax treaty benefits

Three recent Tax Court cases in which the taxpayers were unsuccessful illustrate what foreign students can do differently to qualify for exemption from tax under a treaty.
By Allen Schulman

Many nonresidents who come to the United States as scholars appeal to the Tax Court claiming benefits under a tax treaty. Three recent cases provide tips to decide if it's worth the time and effort to appeal to the Tax Court. Three different U.S. tax treaties are covered: those with Russia, Poland, and China.

Dovzhenok, T.C. Summ. 2017-86

Andrey Dovzhenok was a citizen of the Russian Federation who entered the United States on an F-1 student visa to pursue a graduate degree at a U.S. university. Due to his scholastic success, he was awarded research assistantships over multiple years, which included a cash stipend plus partial tuition discount and health insurance.

The assistantships' award letters said that he would be provided with financial support for graduate study toward a Ph.D. and must work for the university "at 50% FTE (full-time equivalent)," requiring 20 hours of work weekly during the fall and spring semesters and 10 hours of work weekly during one of two summer sessions. The award letters also stated that Dovzhenok's financial support was derived from grants to two of his professors. Dovzhenok submitted a Form 9210, Alien Status Questionnaire, to the IRS, stating that he was employed in the United States by the university. He received Forms W-2, Wage and Tax Statement.

Dovzhenok claimed that he was exempt from U.S. taxation under Article 18 of the United States–Russia tax treaty. Article 18, as applied to this case, deals with payments received by a nonresident individual from Russia who is temporarily present in the United States for the primary purpose of (1) studying at a university or other accredited educational institution; (2) securing training required to qualify him to practice a profession or professional specialty; or (3) studying or doing research as a recipient of a grant, allowance, or other similar payments from a governmental, religious, charitable, scientific, literary, or educational institution.

Article 18 exempts from taxation by the host country (in this case, the United States) any "grant, allowance, or other similar payment[ ] from a governmental, religious, charitable, scientific, literary, or educational organization."

However, the IRS cautions: "An alien student, trainee, or researcher may not claim a scholarship or fellowship treaty exemption against income that has been reported to him or her on Form W-2 as wages" (IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities, p. 33 (Feb. 13, 2018)).

The court ruled that the treaty did not apply to Dovzhenok because:

  1. The award letters specifically required work for the university;
  2. The university provided Dovzhenok with an office and health insurance;
  3. The university withheld income taxes on the payments and issued Forms W-2;
  4. In his Form 9210, Dovzhenok stated that he was "employed" in the United States by the university; and
  5. At trial, Dovzhenok acknowledged that he did not have a grant letter, plus he acknowledged that he had no connection to the grants that had been awarded to the professors for whom he worked. (He also submitted to the IRS a Form 9250, Questionnaire — Tax Treaty Benefits, which acknowledged that he received a salary from the university, and mentioned no grant.)

Lessons learned:

  1. A scholar should have a letter explicitly stating the details of any grants;
  2. A Form W-2 is proof of payment from employment and not a grant; and
  3. Form 9210/9250 must not state that the person is an employee.

Klubo-Gwiezdzinska, T.C. Summ. 2017-45

Joanna Klubo-Gwiezdzinska was a Polish resident who accepted a job as a research fellow at a U.S. hospital that is a nonprofit under Sec. 501(c)(3). Her offer letter stated, "This will be a fully salaried and supported position . . . " She entered the United States on a J-1 visa and a month later signed an employment contract with the hospital.

Klubo-Gwiezdzinska contended that payments she received from the hospital were not taxable income either under Article 18, "Students and Trainees," or Article 17, "Teachers," of the United States–Poland treaty of 1974. The court disagreed with both assertions.

Under Sec. 871(b) and Sec. 864(b), a nonresident alien who receives compensation for the performance of personal services in the United States has income effectively connected with the conduct of a trade or business in the United States and therefore has gross income. See Secs. 864(c)(1)(A), 864(c)(2), 871(a)(1)(A); Regs Sec. 1.864-4(c)(6)(ii). However, under Sec. 894(a), a treaty can alter this income tax liability.

The court listed the following reasons why the income was not "a grant, allowance, or award" under treaty Article 18(1)(a)(iii):

  1. The employment contract mentioned that Klubo-Gwiezdzinska will "earn a salary";
  2. Under the employment contract, Klubo-Gwiezdzinska received benefits, such as paid time off (including vacation, sick, or personal time), liability insurance, health and disability insurance, and family or medical leave of absence, which generally indicate an employment relationship;
  3. The employment contract gave the hospital the right to terminate Klubo-Gwiezdzinska "for any legitimate reason" — the right to discharge a worker indicates an employer-employee relationship;
  4. The hospital issued her Forms W-2;
  5. The Forms W-2 indicated that she was an active participant in a retirement plan sponsored by the hospital; and
  6. The hospital's Forms 990, Return of Organization Exempt from Income Tax, reported no monetary grants or other assistance to individuals for its fiscal years covering the calendar years at issue.

Notably, even though the IRS admitted mistakenly allowing an exemption of $2,000 under treaty Article 18(1)(b)(iv), it did not seek to undo that allowance. No explanation is given in the case why this $2,000 was a mistake or why the IRS didn't pursue the money.

The court also stated, contrary to Klubo-Gwiezdzinska's arguments, the fact that an individual gains experience and greater knowledge through work does not mean that the individual is not also providing a service to the organization for which she works.

Alternatively, Klubo-Gwiezdzinska claimed the income was exempt under Article 17. Under Article 17, if a resident of one of the contracting states is invited by a university or other recognized educational institution in the other contracting state to teach and/or do research for a period not expected to exceed two years at that university or other recognized educational institution, the resident's income from personal services for teaching or doing research is exempt from tax.

The court pointed out that since the phrase "recognized educational institution" is not defined in the treaty then the court must follow Article 3, paragraph 2, of the treaty, which provides that "Any . . . term not defined in this Convention shall, unless the context otherwise requires, have the meaning which it has under the laws of the Contracting State whose tax is being determined."

Therefore, the court turned to U.S tax law for a definition of "recognized educational institution". Under Regs. Sec. 1.170A-9(c)(1), an "educational organization does not include organizations engaged in both educational and noneducational activities unless the latter are merely incidental to the educational activities" (emphasis added).

The court determined that the noneducational activities of the hospital (caring for patients) was not "merely incidental" to any educational activity. Also, the hospital's Forms 990 expressly stated that it is not a school described in Sec. 170(b)(1)(A)(ii). Thus, Klubo-Gwiezdzinska's income from her job as a research fellow at U.S. hospital was not exempt from federal taxation.

Lessons learned:

  1. The fact that an individual may gain experience and greater knowledge through work does not mean that the individual is not also providing a service; and
  2. A teaching hospital may not qualify as an educational institution.

Ye, T.C. Memo. 2017-216

The Tax Court ruled that the wages paid to Zhongxia Ye as an assistant professor were not exempt from tax under Article 19, "Teachers, Professors, and Researchers," of the China–United States tax treaty of April 30, 1984.

Ye, a Chinese resident, entered the United States on an F-1 visa to pursue a Ph.D. In the final year of her Ph.D. program, she applied for several teaching positions and accepted a permanent, full-time, tenure-track position as an assistant professor at Kennesaw State University (KSU). She eventually gained her H-1B visa with the help of the university, and later applied for permanent residency. Her university employer sent to the U.S. Citizenship and Immigration Services an employment verification letter on her behalf that stated: "Her employment will be on an ongoing basis pending approval of her permanent residency."

For each of the tax years 2008 and 2009, Ye filed Forms 9210 and 9250 in which she stated that she intended to stay in the United States "until my employment contract is not renewed."

Ye claimed that on her 2008 and 2009 returns that her income from her teaching position at KSU were exempt from tax under Article 19 of the China–U.S. tax treaty. The IRS sent her notices of deficiency for both years, determining that her wages were includible in income because she was a resident alien for both years and the wages were not exempt from tax under Article 19 of the Treaty.

Ye had reported that she was present in the United States for 183 days in both years, and at trial she did not address the issue. Therefore, the court found that, based on the record before it, Ye met the substantial presence test in Sec. 7701(b)(3) for 2008 and 2009 and consequently was a U.S. resident for tax purposes in those years. An important visa-related point that the court made is that "[w]hile an individual may be treated as 'not' being in the United States for any day where the individual is considered exempt, such as a teacher who is temporarily present in the United States pursuant to a J or Q visa, such an exception does not apply where the individual holds an H-1B visa" (Ye, T.C. Memo. 2017-216 at *10, citing Secs. 7701(b)(3)(D)(i), (5)(A)(ii), and (C)).

However, Article 19 provides that a Chinese resident who is temporarily present in the United States primarily for "teaching, giving lectures, or conducting research at a university, college, school or other accredited educational institution or scientific research institution" is exempt from U.S. income tax for up to three years on teaching and research income. Ye claimed that she was temporarily present in the United States in 2008 and 2009 and, thus, her teaching wages were exempt from U.S. tax. Another important tax treaty point the court made is that even though Ye was a resident of the United States for tax purposes, if she met the requirements of Article 19 she was exempt from tax by virtue of the saving clause in the 1984 protocol to the treaty.

Ye contended she was temporarily present in the United States because a number of contingencies could have resulted in her returning to China. The IRS countered that Ye was not temporarily present in the United States at the time she filed her returns because the occurrence of those contingencies was too remote.

The Tax Court found that Ye did not qualify as temporarily present because:

  1. She had no plan to move out of the United States;
  2. She left the United States only two times, for a total of 33 days, since she arrived in the country in 2001;
  3. She accepted a permanent, full-time, tenure-track job;
  4. Her career goal was to become a full-time professor; and
  5. She applied for a permanent residency.

The court stated, "In short nothing in the record suggests petitioner had any plans to move out of the United States."

The court dismissed Ye's contention that various contingencies, including her employment status, could affect her presence in the United States, because there was nothing to suggest she or the university intended or considered her employment to be temporary. The court pointed out that:

  1. The university renewed her contract;
  2. She was on a tenure track;
  3. Her job rating was positive; and
  4. The university sent Ye a letter stating that she was making sufficient progress toward tenure.

The lessons learned in the above three cases will help foreign researchers and teachers avoid an unpleasant run-in with the U.S. tax system by correctly qualifying for their tax treaty status and obtaining documentation that substantiates that status.

Allen Schulman is an enrolled agent in Lakewood, N.J. To comment on this article or to suggest an idea for another article, contact senior editor Sally Schreiber at Sally.Schreiber@aicpa-cima.com.

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