The good news is that if you qualify as a nonresident alien, the IRS only wants to collect income tax on money that you made in the United States. To make things simple — hah! — the IRS has identified two broad categories of nonresident income that are subject to U.S. taxes:
- Effectively connected income (ECI) – If you have a job in the U.S. or run your own business, that income is "effectively connected" to an American trade or business
- Fixed, determined, annual or periodical (FDAP) income – This category captures everything that isn't ECI, including dividends and interest on investments, alimony, Social Security benefits (85 percent) and miscellaneous income like scholarships and sales commissions
Why does the IRS differentiate between ECI and FDAP income? Because the feds tax the two types of nonresident income at different rates. Effectively connected income is taxed at the same graduated income tax rates that U.S. citizens pay. The more you earn in ECI, the higher your effective tax rate will be. The biggest difference between resident and nonresident tax rates is that married nonresidents cannot file jointly [source: IRS]. The only way a nonresident can file jointly is if they are married to a U.S. citizen or resident, at which point they would file a regular tax return.
FDAP income is taxed at a flat rate of 30 percent [source: IRS]. It's important to note that FDAP is not the same as a capital gains tax. Non-U.S. citizens only have to pay capital gains tax on the sale of stock and other capital assets if they reside in the U.S. for 183 days or more during the tax year. That capital gains tax rate is also 30 percent.
To further confuse things, there's a completely separate capital gains tax for the sale of real property by a foreigner, regardless of his or her status as a resident or nonresident alien. If a non-U.S. citizen sells a piece of U.S. real estate, 10 percent is withheld from the sale price as a capital gains tax [source: IRS]. Higher tax rates apply to real property sold or distributed by foreign corporations.