That's a layered question, but I'll give you an answer to each question:
- How big of a problem is it that I changed form W8BEN to W9 when my H1B visa was issued? What would be potential actions that IRS could follow?
It depends, but the consequences (if any) should be minimal. (Filing as a dual resident will likely eliminate any consequences, by the way). Since Form W-8BEN is used to determine required withholdings for the Nonresident Alien (whereas there are no withholdings if you file Form W-9), the potential consequence is that if you file Form 1040NR, your tax rate could be such that you are in effect underwithheld for the year, which could mean tax due on your filing, and, if your withholdings are not sufficient, then you could face penalties/interest. However, as long as you file/pay on time those penalties and interest are relatively minimal. There's no reason to believe that you face any criminal or other serious consequences.
- Is it better to file "dual status" since W9 does apply for H1B that meets the presence test?
The W-9 is irrelevant. It is probably better to file dual status because you will likely pay less tax. You are correct that you have the option to either file as a dual-status alien or as a Nonresident alien. And filing as a Nonresident Alien is simpler (because it's only the one tax form). But you will probably pay more tax if you do. Here's how dual status works: you pay tax at Nonresident Alien rates for the "NRA" portion of the year on your US-sourced income, and for the resident portion of the year, you pay US-resident tax rates on all of your worldwide income. The US resident tax rate allows for a much greater standard deduction and lower tax rates, so it usually is better to elect dual-residency. However, it could make sense for you to claim NRA status for the entire year under the following two circumstances:
- You have significant (and exclusive) self-employed income during the "resident" period. If you file as NRA, you don't pay self-employment tax (around 15%). However, the higher NRA tax rate will make this a wash. Still, since you are not saving significant tax money filing dual-resident in this scenario, filing only 1040NR would be simpler.
- You have significant worldwide income that is not otherwise "US-sourced" during your residency period. If you file as a NRA, you won't claim nor pay tax on income that is not US-sourced, whereas if you elect to be taxed as a resident in that period, you do pay tax on all of your income. This doesn't guarantee that you will necessarily pay more in US tax, because, if the non-US income is taxed to another country, you will likely qualify for Foreign Tax Credit to offset the US tax liability created.
It also would make sense to file only Form 1040NR if you do not anticipate that you will meet the substantial presence test in 2022, because if you don't, you don't qualify to file as a dual-resident alien.
- Is there any way to correct this in the 1040-NR? That is, pay the taxes that should've been withheld.
Yes. In fact, as I pointed out in question 1, that is exactly what will happen if you file Form 1040NR: your tax situation will be reconciled as a Nonresident Alien for the year, and if you did not have enough withholdings to cover that tax liability, you will pay the balance along with your filed tax return.
The beauty is that you have a legitimate option to go either way with this. For any portion of the year that you are reporting on Form 1040NR, you will use Sprintax for that, since TurboTax does not support 1040NR. For more information on dual-residency status, see this website: Taxation of Dual-Status Aliens | Internal Revenue Service
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