Ron Berman @ Haas

Intro

After moving to the US, I had to submit a tax report (called a tax return) for the first time in my life. I found an intricate list of details, rules, forms and what not to deal with. It intrigued me…

I later obtained certification for being a Tax Preparer in California.

As an international student, I found it hard to understand my rights (and wrongs), and found the information supplied to us by the university, and the software that came with it, extremely lacking.

I found out that in many cases it is possible to pay less taxes (or get a higher refund) by just completing the right form.

Given how cash-strapped grad students are, I wrote this list of tips, to help students maximize their tax benefits.

Any comments, corrections and suggestions for this project are welcome. Feel free to contact me using my contact information in the About page.

Disclaimer

The text below does not constitute tax advice or recommendation, and does not replace professional consulting. The details were collected according to the author’s best of knowledge. The author holds no responsibility and cannot be held accountable for any implications resulting from actions taken based on this text. Use the information at your own risk. It is always advisable to seek professional tax, legal and financial advice regarding tax issues.

Contents

The tips are contain many items, and are therefore divided into smaller subsections:

1. Federal Taxes
   • Tax Treaties
   • Maximizing Credits and Deductions by using the proper form
   • Adjustments to income
   • Itemizing Deductions
   • Extra Items
2. California Taxes
   • Non-resident or resident forms?
   • Adjustments to income

Federal Taxes

There are basically two (legal) ways to minimize the taxes you pay, or maximize your refund: make sure you receive all tax treaty benefits you are entitled to, and claim all the deductions you can.

Because the number of items in some sections is quite large, the content of several sections was moved to pages of their own with a link here.

Tax Treaties

Many foreign countries sign on agreements with the U.S. to make sure citizens of the foreign countries do not pay double taxes on their income. The agreements, called “tax treaties”, give many benefits, including lowered tax rates on many type of income. In many cases, certain types of income, such as scholarships and fellowships, and also certain types of gains, such as capital gains, are completely exempt from taxes, and are tax free.

The tax treaty details and rules are complex, and change according to each country of origin. A good summary can be found in IRS Publication 901.

The 3 short tables at the end of the publication summarize most of the relevant details according to country of origin. It is better to first look at them instead of reading throughout the entire document.

Maximizing your deductions by submitting form 1040NR instead of 1040NR-EZ

Deductions are sums of money which that can deduct from your income before tax is calculated. The more deductions you have, the less tax you will pay and the higher refund you might get.

US residents and citizens are allowed to deduct a “standard deduction” from their income (which is $5900 in 2009 for a single). Non-residents, unfortunately, cannot deduct this large amount, which means that in order to pay less tax they must specify each deduction they are entitled to on their tax return forms.

The majority of tax preparation software your school will supply you with, or that you will find online will help you fill out the IRS 1040NR-EZ form. This 2 page form (called EZ for “easy”) takes a short time to fill, but does not let you claim all of the deductions many graduate students can claim.

This means that as a general rule, it is almost always worthwhile to spend some time on filling out the longer 1040NR form.

A list of some common deductions for which students might be eligible is described below.

Adjustments to income

Adjustments to income are deductions which can be claimed directly on the 1040NR form. This means that the entire amount spent on eligible expenses can be subtracted from the total income you had.

The list of relevant deductions is contained in a page of its own: most relevant adjustments for nonresident graduate students, and other foreign employees.

Itemize Deductions

California Taxes

This page is part of a larger article on how foreign students can save on their taxes.

Any comments, corrections and suggestions for this project are welcome. Feel free to contact me using my contact information in the About page.

Disclaimer

The text below does not constitute tax advice or recommendation, and does not replace professional consulting. The details were collected according to the author’s best of knowledge. The author holds no responsibility and cannot be held accountable for any implications resulting from actions taken based on this text. Use the information at your own risk. It is always advisable to seek professional tax, legal and financial advice regarding tax issues.

Scholarship and fellowship grants

Scholarships and fellowships are generally tax exempt only if they are used to pay for tuition, fees and other “Qualified education expenses”. Any extra amounts, including ones used to pay for living expenses, are treated the same as other types of wage. In many cases, however, a tax treaty treats this types of income differently, allowing for a lower tax rate on scholarships and fellowships. The condition is typically that these amounts of money were given to a student without any condition for work or other services in exchange.

This means that a student should prefer to receive his income as a scholarship and not as regular compensation for work.

As an example, if your school pays you a stipend of $20,000 a year in two parts: $10,000 as a scholarship and $10,000 in return for being a teaching assistant, you might want to ask them to split the income differently, if possible, and to pay you a smaller percentage as salary, as long as the rules allow it.

The treatment of Scholarship and Fellowship income is described in Publication 970 and in Publication 519.

Qualified Higher Education expenses

Studying for a graduate degree entails many expenses related to your studies. Such expenses may include textbooks, software licenses, office supplies, materials and tools and other course related expenses.

If those expenses are required from all course participants, you can deduct them from your scholarship income.

Full details of what can and cannot be deducted appear in Publication 970.

Dependents

Many graduate students turn into parents or have other dependents while they study. You may be eligible for different tax credits and deductions for your dependents.

Many of the details can be found in the instructions for form 1040NR.

Moving Expenses

As a foreign student, you probably had some significant moving expenses which may include airfare or other travel expenses, shipping costs and lodging costs.

All of these expenses are fully deductible on the year you had moved, and can yield significant tax savings.

Calculating the amount of expenses to deduct is done using IRS Form 3903, which also includes short explanations.

The full details of what can and cannot be deducted appear in IRS Pub. 521.

Student Loan expenses

If you took a student loan, or paid for a dependent’s student loan, you can typically deduct the interest paid and other expenses related to the loan. More details and a worksheet used to calculate the allowed deduction can be found in the instructions for form 1040NR.

Invest in an IRA for retirement

Graduate students typically don’t think about saving for retirement, as they are just beginning their careers. This is a dear mistake - the early you start saving for retirement, the easier it will be for you to reach substantial amounts at an older age because of a compounded interest effect.

The government would like people to save for retirement, and incentivizes them to do so in the form of a tax benefit for people who put aside money every year in an IRA - an Individual Retirement Account. Putting money into an IRA means that you cannot access the money until a very late age. Many graduate students cannot afford to use the small income they get for such long term savings. If you can afford to save, however, it might be worth your while.

Several types of IRA accounts exist; the primary ones are referred to as a Traditional IRA and a Roth IRA.

Amounts of up to $5000 per year (for a single in 2009) can be put into a traditional IRA, and be deducted from your income. These amounts will later be taxed when you retire and take money out of the IRA account.

A Roth IRA, on the contrary, is an account where the money you put in today is not taxed when it is withdrawn at retirement. You cannot, however, deduct the investment from your current income.

Several rules guide how much money you can contribute every year and into which type of account. The general decision rule says that if you expect your retirement income to be higher than your income today, than you should opt for a Roth IRA. If your expected retirement income is lower than your income today, go for a traditional IRA.

The difference is when taxes are calculated - you would like to pay taxes when your income is lower and the tax rate on the income is also lower.

Saving for retirement and the optimal way of doing so is a big issue, and typically requires professional advice.

Domestic production activities

If you held a business in the US, or were a partly owner of a business that paid employees to produce real estate, software, film or perform engineering tasks in the US, you might be able to deduct additional amounts on those paid in your tax return.

Such a deduction might be relevant to architects, engineers and software developers who employ other people as part of a project.

Form 8903 is used to report such activities, and its details appear in the form 8903 instruction pages.

Additional write-in adjustments

Form 1040NR allows for additional deductions called “write-in” deductions which are just calculated into the total amount of deductions.

The list of such possible deductions and the method for reporting them on your tax return appear in the instructions for form 1040NR.