By: Yitian Cai

Previously, our blog has discussed the H-1B “startup visa,” both in the context of the H-1B visa being a workaround for immigrant entrepreneurs and the Trump administration’s impact on startups’ utilization on the visa. However, many early stage startups can’t realistically afford to sponsor a candidate for H-1B visa. More importantly, a significant portion of these startups spring out of academic and academically related contexts, and the foreign talent – either as founders themselves or as someone the founders would like to work with – could still be in school in the U.S., potentially on a F-1 student visa. Both Optional Practical Training (OPT) and Curricular Practical Training (CPT) remain two very popular avenues for an international student entrepreneur on an F-1 status to work for a startup business. This post looks at some important employment tax issues in relation to a startup’s engagement of a foreign student authorized to work for that company under either CPT or OPT. Specifically, it provides some guidance on the circumstances where Social Security and Medicare taxes need to be paid and withheld on behalf of the worker if the they are classified as an employee, and where they need to be paid by the worker themselves if they are classified as an independent contractor.

The Federal Insurance Contributions Act (“FICA”) requires that taxes be 1) withheld from employees’ wages and 2) contributed by their employers for old-age, survivors, and disability insurance (collectively known as the “Social Security taxes’) as well as the hospital insurance (otherwise known as “Medicare taxes”).[1] The self-employed worker’s equivalent of FICA is known as Self-Employed Contributions Act (“SECA”). This blogpost refers to taxes paid under FICA and SECA as FICA and SECA taxes, respectively.

Both FICA and SECA taxes total at a rate of 15.3% of a worker’s wages.[2] In the case of FICA, the employer and the employee share the tax burden equally, each paying 6.2% and 1.45% of Social Security and Medicare taxes, respectively.[3] In the case of SECA taxes, all 15.3% of the taxes are to be paid by the independent contractor worker alone.[4] Social Security taxes are also subject to a wage limit. For tax year 2019, this limit is $132,900, meaning the first $132,900 of a worker’s wages is subject to the Social Security taxes.[5] That wage limit is $128,400 for tax year 2018.[6]

An F-1 student with OPT or CPT employment authorization can be employed either as an independent contractor or as an employee.[7] OPT and CPT stands for Optional Practical Training, and Curricular Practical Training, respectively. They are two types of work authorization allowing international students on F-1 status to work either during an academic semester or after the completion of their degree. Whether an F-1 student needs to withhold and pay FICA or SECA taxes for wages received while employed under OPT or CPT depends on whether the student qualifies as a tax resident.

 

Tax Residency

            The classification of a taxpayer as either a “resident alien” or a “nonresident alien” matters with respect to their liability for FICA or SECA taxes, as the case may be. Both the Social Security Act (SSA) and the Internal Revenue Code (IRC) exempt F-1 students from FICA and SECA taxes for as long as they remain “nonresident aliens.”[9] The IRS has promulgated the Substantial Presence Test, among other tax residency tests, in stipulating that F-1 students will be assumed to be nonresident aliens only to the extent that the assumption is consistent with the residency rules of IRC § 7701(b).[10] Under those rules, the exemption from FICA and SECA taxes ceases to exist when the payee becomes a “resident alien.”[11]

 

Substantial Presence Test

An F-1 student will be considered a resident alien for U.S. tax purposes if they meet the Substantial Presence Test for the calendar year under the residency rules of IRC § 7701(b).[12] To meet this test for tax year 2018, for example, the student must be physically present in the U.S. on at least:

  1. 31 days during 2018, and
  2. 183 days during the 3-year period that includes 2018 and the 2 years immediately before 2018, counting:
  • All the days they were present in 2018, and
  • 1/3 of the days they were present in 2017, and
  • 1/6 of the days they were present in 2016.[13]

The application of the Substantial Presence Test to the F-1 student does not count the days for which the student is an exempt individual.[14] In the case of this student, being an exempt individual means being present U.S. on the F-1 status, including any period the student is under OPT and CPT work authorization, and substantially complying with the requirements of their visa.[15] But the student will no longer be an exempt individual if they have been exempt as an F-1 student for any part of more than 5 calendar years unless they (1) establish that they do not intend to reside permanently in the U.S. and (2) have substantially complied with the requirements of their visa.[16]

 

Conclusion

The determination of whether a worker who is an F-1 student with CPT or OPT authorization is subject to FICA or self-employment taxes in most cases might stop at inquiring the nonimmigrant status of the worker. But the inquiry should not stop there, especially when the worker is known to have been present in the U.S. for some years. It is advisable to look into the years for which the worker has been an F-1 student in the U.S., and to apply the Substantial Presence Test to determine if they should be treated as a resident alien for U.S. tax purposes.

[1] https://www.irs.gov/taxtopics/tc751

[2] https://www.irs.gov/taxtopics/tc751; https://www.irs.gov/businesses/small-businesses-self-employed/self-employment-tax-social-security-and-medicare-taxes#2

[3] https://www.irs.gov/taxtopics/tc751

[4] https://www.irs.gov/businesses/small-businesses-self-employed/self-employment-tax-social-security-and-medicare-taxes#2

[5] https://www.journalofaccountancy.com/news/2018/nov/social-security-wage-base-2019-201820059.html.

[6] Id.

[7] http://www.bu.edu/isso/employment-internships/student-off-campus-work-and-training/optional/optemployment-types/; https://internationalaffairs.uchicago.edu/sites/internationalaffairs.uchicago.edu/files/uploads/docs/taxwithholdings2012.pdf

[8] https://www.irs.gov/individuals/international-taxpayers/foreign-student-liability-for-social-security-and-medicare-taxes

[9] Id.

[10] Id.

[11] Id.

[12] https://www.irs.gov/individuals/international-taxpayers/substantial-presence-test

[13] https://www.irs.gov/individuals/international-taxpayers/substantial-presence-test

[14] Id.

[15] Id.

[16] IRS Publication 519, Page 6 (https://www.irs.gov/pub/irs-pdf/p519.pdf).