Russian Citizen's Wages Are Exempt from U.S. Tax under U.S. - Russia Treaty

(Parker Tax Publishing January 2020)

The Tax Court held that wages received by a Russian citizen may be eligible for an exemption from U.S. income tax under the U.S.-Russia Treaty so long as they are payments similar to a grant or allowance. In the instant case, the court concluded that the wages received by the taxpayer were payments similar to a grant or an allowance and were therefore exempt from federal income tax. Baturin v. Comm'r, 153 T.C. No. 10 (12/18/19).

Background

Vitaly Baturin is a Russian citizen. At some point before 2007, while he was working in South Korea, he was invited by the University of California, Los Angeles (UCLA) to participate in an exchange visitor program as a research scholar. Baturin was issued an Exchange Visitor J-1 visa to participate in the program. He traveled to Mainz, Germany, to conduct his research. At some point, the UCLA program was canceled and then Jefferson Science Associates, LLC (JSA), offered Baturin a two-year position in the Physics Division at the Thomas Jefferson National Accelerator Facility (Jefferson Lab). JSA manages and operates the Jefferson Lab for the U.S. Department of Energy's Office of Science. JSA's work is primarily research for the public interest, not for private benefit. JSA personally invited Baturin to join the Jefferson Lab and perform his research; there was no application process. Baturin understood that JSA characterized him as an employee because he used very complex equipment requiring a lot of training, security tests, security exams, and insurance.

A responsible officer of JSA prepared a Form DS-2019, Certificate of Eligibility for Exchange Visitor J-1 Status, for Baturin. The responsible officer wrote: "Transfer of this exchange visitor from program number P-1-100181 sponsored by University of California, Los Angeles to the program specified in item 2 is necessary or highly desirable and is in conformity with the objectives of the Mutual Education and Cultural Exchange Act of 1961, as amended." Form DS-2019 states JSA's program number as P-3-05511 and the "Official Description" as "Research Scholar; Short-term Scholar; Specialist." It refers to JSA as the "Program Sponsor" and to Baturin as an "Exchange Visitor."

According to Box 5 on Baturin's Form W-2, JSA's "Current Program Sponsor funds" were $75,000, the same amount stated as his salary when he was hired. Baturin was told that Jefferson Lab funded his program and set aside these funds for his maintenance before his arrival in the United States, pursuant to Department of State requirements. Baturin did not receive financial support from anyone other than JSA. His exchange visitor term began January 1, 2007, and was extended several times through May of 2015. With respect to the last extension of his position, JSA filed an H-1B Temporary Worker visa application, rather than another Form DS-2019. The Department of Homeland Security's Form I-797A, Notice of Action, with regard to Baturin described the "case type" as "petition for a nonimmigrant worker."

Baturin's Tax Returns and IRS's Deficiency Assessments

Baturin considered himself an employee of JSA. For each of the tax years 2010 and 2011, Baturin received a Form W-2 from JSA reporting amounts paid and federal income tax withheld. The Forms W-2 show that JSA also withheld social security and Medicare taxes. Baturin timely filed Form 1040NR, U.S. Nonresident Alien Income Tax Return, for the 2010 tax year, claiming among other things that his income was exempt under Article 18, Section 1(b) and (c) of the U.S.-Russia Treaty. Baturin received a refund for the 2010 tax year. He timely filed another Form 1040NR for the 2011 tax year once again claiming that his income was exempt under the U.S.-Russia Treaty. He did not receive a refund for the 2011 tax year.

The pertinent part of Section 1 of Article 18, Students, Trainees and Researchers, of the U.S.-Russia Treaty provides: "An individual who is a resident of a Contracting State at the beginning of his visit to the other Contracting State and who is temporarily present in that other State for the primary purpose of: ... (c) studying or doing research as a recipient of a grant, allowance, or other similar payments from a governmental, religious, charitable, scientific, literary, or educational organization, shall be exempt from tax by that other State with respect to payments from abroad for the purpose of his maintenance, education, study, research, or training, and with respect to the grant, allowance, or other similar payments."

Additionally, Section 3 of Article 18 provides that the exemption does not apply to income from research "undertaken not in the public interest but primarily for the private benefit of a specific person or persons." Neither may the exemption for research "extend for a period exceeding five years."

In 2017, the IRS issued a notice of deficiency which stated that Baturin owed tax deficiencies of more than $11,000 for 2010 and more than $11,000 for 2011. The IRS argued that Baturin was not entitled to the exemption under the U.S.-Russia Treaty. According to the IRS, because the payments in issue were wages, they were by definition excluded from the Article 18 exemption.

Tax Court's Analysis

The Tax Court began its analysis by noting that, when interpreting a treaty, courts begin with the text of the treaty and the context in which the words are used. The U.S.-Russia Treaty, the court observed, does not define the phrase "grant, allowance, or other similar payments" but does provide that any term not defined in the treaty will have the meaning which it has under the laws of that country concerning the taxes to which the treaty applies. Since the Internal Revenue Code provides no definition of "grant" or "allowance," the court sought to interpret the phrase in context, taking into account the intent, purpose, or expectations of the signatories. The word "grant," the court said, has been broadly defined as an amount of funds given for a specific purpose. The Article 18 exemption from taxation, the court noted, was intended as special relief to visiting students, trainees, and researchers. The court found that the exemption of payments made from abroad extends to those made for a wide range of purposes, including a visitor's maintenance, education, study, research, or training.

The court disagreed with the IRS's contention that wages are categorically excluded from Article 18. Article 18, the court noted, has no requirements for how the "grant, allowance, or other similar payments" must be characterized. Whether an individual who otherwise meets the U.S.-Russia Treaty requirements receives a Form 1099 or a Form W-2, the question should be the same: whether he or she is the recipient of a grant, allowance, or similar payment.

The court stated that a common difficulty faced by it and other courts is distinguishing between two situations. In the first, the foreign taxpayer is the recipient of a grant but an institution is the conduit for the grant application, award, and payment. In the second situation, the institution, or a different individual within the institution, is the recipient of a grant and uses the funds to employ a foreign taxpayer. The Tax Court concluded that the Article 18 exemption applies in the first situation but not in the second.

According to the court, a researcher's salary is not a grant merely because his employer received grants to fund research in his area. On the other hand, a grant does not become a salary merely because an institution reports its payment on a Form W-2. Relevant facts in determining whether a grant, allowance, or other similar payment has been made directly or indirectly to an individual may include the nature of the individual's work and position; whether an application for a grant or award features an individual's research or participation prominently; whether the funds issued were based on that individual's research or participation; whether funds were earmarked specifically for an individual's maintenance; and the individual's immigration status. The court said that the characterization of payments is also a relevant fact; it is simply not determinative. An institution acting as a conduit may characterize payments as wages for its own purposes. If the institution issuing a Form W-2 is the conduit for payment and the individual otherwise meets the requirements of Article 18, indirect payment of a "grant, allowance, or other similar payment" is exempt from taxation.

As a result, the court said that wages may be eligible for exemption so long as they are similar to a grant or allowance. Taken as a whole, the court found that the facts in the record lead to a conclusion that Baturin was the recipient of a grant, allowance, or similar payments and his wages were therefore exempt from federal income tax pursuant to Article 18 of the U.S.-Russia Treaty.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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