Ask Me Help Desk - Resident alien or dual-status alien?

I am from Hungary. I have been working in the USA from 01/11/2010 until 08/31/2012 as a J-1 research scholar. I was absent from the USA 11 days in 2010, and 15 days in 2011. In 2012, I was present in the USA from 01/01/2012 until 09/11/2012 continuously. After that we permanently moved back to Hungary.
For tax year 2012, I received forms 1042-S and W-2 from my employer. On 1042-S there was no tax withholding reported (because of a tax treaty exemption), and on W-2 there is a roughly $3000 withholding.
My wife was with me for the whole time as a J-2 dependent. She did not work in the USA, and she does not have a SSN or ITIN. We had two children who were born in the USA in 2010 and 2012, and they both have SSNs.

My questions are:

1. Do I need to file my tax report as a resident alien or as a dual-status alien?

2. If resident alien is the answer to Q1, how can I report the income on my 1042-S on form 1040?

3. Together with my wife, can we file the tax report as "married, filing jointly"?

4. Are we eligible to deductions and credits after our two children?

Your J-1 exemption ended on 11 January 2012, at which point you became liable for the Substantial Presence Test, which you met in August.

You can file a dual-status return and claim your wife and children as dependents. You probably qualify for the Child Tax Credit. However, you must apply for ITINs for your wife and children.

If you are going to do that, you might as well file a JOINT return and claim all world-wide income for 2012. Once you get the refund and your wife's and children's ITINs (which IS a complicated process now), you would then submit a Residency Termination Statement.

The Form 1042-S income is exempt under the assumption is was for the first 11 days of January 2012.

Thank you for your prompt reply, AtlantaTaxExpert!
Your answer triggered some further questions, however.

1. I am still not sure how to treat the first 11 days in 2012.
What IRS says regarding teachers and trainees as "exempt individuals" (http://www.irs.gov/publications/p519/ch01.html): "You will not be an exempt individual as a teacher or trainee in 2012 if you were exempt as a teacher, trainee, or student for any part of 2 of the 6 preceding calendar years." In my case I was exempt in both 2010 and 2011 calendar years, so in my reading, I will not be an exempt individual in 2012. If my logic is correct, then I have to start counting my days of presence from 01/01/2012 (and not from 01/11/2012). If this is true, it means I have been a resident alien for the whole tax year 2012.

2. If my info regarding the dual-status tax report is correct, there are certain restrictions (Taxation of Dual-Status Aliens), such as we are not allowed to use standard deduction, and we cannot file a joint return, etc. Am I correct?
You wrote: "You can file a dual-status return and claim your wife and children as dependents." I thought spouses cannot be claimed as dependents. Under our circumstances is it possible to claim her as my dependent?

3. Under our circumstances and assuming a dual-status report, am I required to file as "Resident Alien at End of Year"?

4. To apply for an ITIN for my wife (our children already have SSNs), we have to submit Form W-7 for her together, in the same envelope as our tax report, do we not?

5. My employer reported income for the first 3 months of 2012 on form 1042-S for some reason. Do I need to do anything about it, like asking them for a correction to report my income after 01/11/2012 on a form W-2?

The tax treaty reads "two years from date of arrival", so the first eleven days ARE exempt.

If you file dual-status, your year-end status will be non-resident even though you started the year non-resident, so filing a joint return would be simpler, especially if you choose not to be in exempt status for the first eleven days.

Yes, you do have to submit Form W-7 with the tax return. If you file jointly, you also have to claim any Hungary income earned in 2012, and submit form 1116 to claim the Foreign Tax Credit for any Hungarian taxes paid.

Quote:

Originally Posted by AtlantaTaxExpert

The tax treaty reads "two years from date of arrival", so the first eleven days ARE exempt.

If you file dual-status, your year-end status will be non-resident even though you started the year non-resident, so filing a joint return would be simpler, especially if you choose not to be in exempt status for the first eleven days.

Yes, you do have to submit Form W-7 with the tax return. If you file jointly, you also have to claim any Hungary income earned in 2012, and submit form 1116 to claim the Foreign Tax Credit for any Hungarian taxes paid.

Thanks for the reply again! I think I am starting to see a bit clearer... :)

I think we are talking about two different kinds of exemptions.

You wrote about the J-1 tax treaty exemption, which is exemption from US tax.

When I wrote "exempt individuals", I was referring to exemption from counting days under the substantial presence test. According to IRS:
"Do not count the following as days of presence in the United States for the substantial presence test.
[... ]
Days you are an exempt individual.
[... ]
Exempt individual. Do not count days for which you are an exempt individual. The term “exempt individual” does not refer to someone exempt from U.S. tax, but to anyone in the following categories.
[... ]
A teacher or trainee temporarily present in the United States under a “J” or “Q” visa, who substantially complies with the requirements of the visa."

So what I meant is that in 2012 I need to count my days of presence because I was an exempt individual in the 2 previous years (2010, 2011), so I am not exempt from counting days anymore in any part of 2012.

I have a fundamental question:
Filing a dual-status tax return is an OBLIGATION, or a POSSIBILITY? So If I were a dual-status alien in 2012 (and it seems I was) do I have to file a dual-status return, or can I choose to file a return as a resident alien?
I am asking because as you pointed out, a 'married, filing jointly' tax return as resident aliens using Form 1040 would be so much easier for us to do.

You have the choice:

1) File dual-status, claim wife and children as dependents, do NOT claim standard deduction and pay taxes ONLY on U.S. income.

OR

2) File jointly, claim joint standard deduction

2) File joint resident return, claim joint standard deduction of $11,900, claim $2,000 in child tax credits, but declare ALL world-wide income.

Quote:

Originally Posted by AtlantaTaxExpert

2) File joint resident return, claim joint standard deduction of $11,900, claim $2,000 in child tax credits, but declare ALL world-wide income.

Great news! So far I was trying to figure out a way to somehow fit into the "resident alien" tax return category and escape the dual-status return. I was not aware that this can be a simple choice. :)
Together with the standard deduction, the four exemptions, the child tax credits and the high Hungarian tax rate, this will be our way to go.
Can you please provide any references (be it an IRS Publication or whatever) which states that I can choose to be treated as a resident alien for the whole tax year in this case? It is not that I don't trust you, I just want to see something "official".

Will the following way be OK to report my income on form 1042-S?:
"How to report income on your tax return. [... ] However, if the income has been reported as taxable income on a Form W-2, Form 1042-S, Form 1099, or other information return, you should report it on the appropriate line of Form 1040 (for example, line 7 in the case of wages, salaries, scholarships, or fellowships). Enter the amount for which treaty benefits are claimed in parentheses on Form 1040, line 21. Next to the amount write “Exempt income,” the name of the treaty country, and the treaty article that provides the exemption. On Form 1040, subtract this amount from your income to arrive at total income on Form 1040, line 22." (source: http://www.irs.gov/publications/p519/ch09.html)

Thank you in advance!

I cannot tell where to find it explicitly. It is more or less implied by reading the criteria for First Year Choice and the option of claiming 31 December of the departure year as your DEFAULT termination date.

I HAVE filed several returns like yours in the past with no problems.

Quote:

Originally Posted by AtlantaTaxExpert

I cannot tell where to find it explicitly. It is more or less implied by reading the criteria for First Year Choice and the option of claiming 31 December of the departure year as your DEFAULT termination date.

I HAVE filed several returns like yours in the past with no problems.

Thank you very much again! You made our tax return a LOT easier!

Now I have only some final technical questions:

1. How can I report my Form 1042-S income on Form 1040? I wrote what I have found so far in post #8. Would that be OK?

2. What kind of foreign exchange rate should I use to convert my Hungarian earnings into USD?

1) Report it on line #7 of Form 1040.

2) Use the yearly average.