Federal Non-Effectively Connected (NEC) income and state

A nonresident alien (NRA) needs to report Non-Effectively Connected (NEC) income on schedule NEC of Form 1040-NR. The income will bypass the AGI but separately taxed. As such the income will not flow to the state, how do we solve the problem?

The question can be divided to two sub-questions.

First of all, it is a theoretical question: Is the NEC income subject to state tax?

I could not find direct answer from state's instruction. I guess the instruction does not cover every odd case, but by reasoning I would say yes, as far as the state is concerned, for the most part, an NRA for federal purpose is a normal resident if she lives in the state full year and is subject to the same rule as any other resident. Am I not right. [There are special cases with federal treaty, some states recognize like MN and some do not like CA].

The second question is a technical question: how do I get the income flow to the states?

An easy way would make adjustments, I cannot do this for CA but not for MN which requires MN AGI to be the same as federal for the purpose of E-file.

The second way is to file a "dummy" resident return for federal.

The third way is to paper file.

I would like to hear if you have the issues, and how do you deal with it.

If you learn about sourcing of fdap income and then you can answer this question.

https://us.eversheds-sutherland.com/por ... _Libin.pdf

Why is a state return required?

Where is the taxpayer living?

What is the nature of the income?
What software are you using?

Wow, so many questions. It is a generic question, but we can be more specific. Let us take a common example that a F-1 student with 5 year stay in the United States living in California, she has an intern income at Google, and also has capital gains and dividends on the side.

She needs to file 1040-NR reporting capital gains and dividends on schedule NEC on federal return, but this the income reported on schedule NEC will not flow to the state when I ProConnect tax software.

So the state is going to treat the student as a nonresident similar to the federal treatment?

A nonresident state doesn’t generally tax investment income like interest / dividends from public companies / cap gains.

So the state is going to treat the student as a nonresident similar to the federal treatment?

A nonresident state doesn’t generally tax investment income like interest / dividends from public companies / cap gains.

Agree. And I’ll add the reason why is sourcing. Sourcing is determined by the nature of the payment not the residency ( or non-residency)of the taxpayer.

So can you tell us who made payments of dividends or attributable to capital gains so we can determine that the amounts are sourced in the US.

So can you tell us who made payments of dividends or attributable to capital gains so we can determine that the amounts are sourced in the US.

The capital gains are paid by the market, and dividends by companies like IBM, Home Depot, GE, etc.

So the state is going to treat the student as a nonresident similar to the federal treatment?

No, the state will treat the student as a resident if she lives in the state.

Doesn’t the US Govt treat the person as a resident too.

Doesn’t the US Govt treat the person as a resident too.

No, a F-1 student within her first 5 year stay in the United States is an exempt individual, i.e. she is not here while she is here, please see the examples: https://www.irs.gov/individuals/interna ... y-examples .

I don't know this off the top of my head, but i guess you do and I'm going to restate what you're saying, that this person is a nonresident for US purposes, but because she resides in CA that state treats her as a resident?

I don't know this off the top of my head, but i guess you do and I'm going to restate what you're saying, that this person is a nonresident for US purposes, but because she resides in CA that state treats her as a resident?

Correct, the state does not care your visa status, if you live in our state, then you are a resident.

If you learn about sourcing of fdap income and then you can answer this question.

I believe the sourcing issue has been solved, IRS has a page dedicated to the topic (capital gain by foreign students):

https://www.irs.gov/individuals/interna ... overnments

Interesting - so with these facts in mind, I’d agree that the state is probably going to view the student as a resident, and the student should file a resident income tax return. You may have to prepare a second return with a pro forma federal return for the state file to link to, similar to what you would have to do with a foreign corporation that claims a treaty position where the state does not follow the treaty.

If you learn about sourcing of fdap income and then you can answer this question.

I believe the sourcing issue has been solved, IRS has a page dedicated to the topic (capital gain by foreign students):

https://www.irs.gov/individuals/interna ... overnments

I’m surprised about this guidance wasn’t expecting a nra capital gains to be taxed in us. However given that can’t you elect to be taxed as a resident and then just file 1040 with state. Thinking you could waive physical presence test.

I’m surprised about this guidance wasn’t expecting a nra capital gains to be taxed in us. However given that can’t you elect to be taxed as a resident and then just file 1040 with state. Thinking you could waive physical presence test.

For the use case I described, there is no election can be made unless the nonresident in question is married to a resident.

I agree. i think Henry David has a good suggestion to prepare two returns ( or put your client in your tax software twice one for the federal and one for the state). That's how i interpreted his response. Sorry i can't be any more helpful except to confirm you have an odd situation.

NY would only tax NY source income. Change in law in 2009

"A dwelling place maintained by a full-time student enrolled at an institution of higher education, as defined in section 606(t)(3) of the Tax Law, in an undergraduate degree program leading to a baccalaureate degree, and occupied by the student while attending the institution is not a permanent place of abode with respect to that student."

State taxation tends to be based on residency.