Here at Cadesky U.S. Tax, we routinely receive enquiries from clients who are either considering moving to the U.S. or who are spending a significant amount of time in the U.S. They want to know on what basis they will be taxed. One significant issue that must first be addressed is to determine their residency status for U.S. tax purposes. It is common knowledge that a U.S. citizen is subject to U.S. taxation and filing requirements regardless of where they live in the world. The question then becomes, for a non-U.S. citizen – when do they become a U.S. resident?
There are, in general, three ways that a non-U.S. citizen can become a resident alien, a U.S. tax resident, for U.S. tax purposes: (i) being lawfully admitted for permanent residence (aka obtaining a green card); (ii) meeting the conditions of the substantial presence test; or (iii) making the first year election. This U.S. Tax Tip will look at the substantial presence test.
The rules are contained in paragraph 7701(b)(3) of the Internal Revenue Code. It is a relatively straightforward days counting test, though there are some statutory modifications. It does not depend on an individual’s unique “facts and circumstances”. It operates on a three-year rolling average whereby, under the test, if the individual exceeds 182 days the individual will be considered to be a U.S. tax resident from the first day of physical presence in the United States.
What constitutes a day?
Any part of a day that an individual is physically present in the U.S. counts as a day (subject to below).
If, for example, you fly into La Guardia airport, in New York City, at 10:30 PM that counts as 1 day of physical presence though you may have only actually been in the U.S. for 1 ½ hours. As such, it has been our experience that many individuals do not count their travel days when computing their total U.S. days. This is clearly wrong and doing so may understate their actual physical presence.
However, in the year that an individual becomes or ceases to be a U.S resident not more than 10 days of physical presence may be excluded when determining the residency start or end date. For these days to be excluded the individual must have a closer connection with a foreign country.
Assume an individual was working in the U.S. on an L-1 visa. He was physically present in the U.S. from January 1 to June 30. He departed the U.S. on June 30th. He then returned for Christmas arriving on December 20th and leaving on December 27th. His time in December was 8 days. These 8 days may be excluded. As such the individual ceased U.S. residency, for U.S. tax purposes, on June 30th. If, however, he had arrived on December 10th and left on the 27th, he would then have 18 days of subsequent U.S. physical presence. Since this exceeds 10 days, they cannot be excluded. Now, the individual ceased U.S. residency on December 27th not June 30th. As such, his worldwide income, from July 1st to December 9th, may now be subject to U.S. taxation. Reliance on an Income Tax Treaty may be required.
In determining residence for state income tax purposes, many states mirror or follow the federal rules. As such, there may be state implications as well as U.S. federal implications. Many states, such as New York, are aggressively targeting non-residents to determine if the individual, in fact, has become a state resident for income tax purposes. This could have the impact of subjecting the individual’s worldwide income to state taxation.
Certain days of physical presence, however, are excluded. These days include days in which the individual can be classified as an “exempt individual”, days where such individual was unable to leave the United States on such day because of a medical condition which arose while such individual was present in the United States or days which are statutorily excluded.
An “exempt individual” includes:
- a foreign government-related individual;
- a teacher or trainee being an individual who is temporarily present in the United States under subparagraph (J) or (Q) of section 101(15) of the Immigration and Nationality Act (other than as a student), and who substantially complies with the requirements for being so present;
- a student – an individual who is temporarily present in the United States— (I) under subparagraph (F) or (M) of section 101(15) of the Immigration and Nationality Act, or (II) as a student under subparagraph (J) or (Q) of such section 101(15), and who substantially complies with the requirements for being so present.; or
- a professional athlete who is temporarily in the United States to compete in certain sporting events.
Statutorily excluded days include days for commuters, transit between two foreign points and crew members that are temporarily present in the United States.
- If an individual regularly commutes to employment (or self-employment) in the United States from a place of residence in Canada or Mexico, such individual shall not be treated as present in the United States on any day during which he so commutes.
- Transit between two foreign points – If an individual, who is in transit between 2 points outside the United States, is physically present in the United States for less than 24 hours, such individual shall not be treated as present in the United States on any day during such transit. For example, if the individual takes a flight from Toronto to Newark, NJ and then later that day takes a flight from Newark, NJ to Manchester, U.K. – that “day” of physical presence in Newark is not a considered a day under the substantial presence test.
- Crew members temporarily present – An individual who is temporarily present in the United States on any day as a regular member of the crew of a foreign vessel engaged in transportation between the United States and a foreign country or a possession of the United States shall not be treated as present in the United States on such day unless such individual otherwise engages in any trade or business in the United States on such day.
Computing the days
First, the individual must have at least 31 days of U.S. physical presence in the current year. This provision provides a de minimis number of days otherwise it would be possible that, under the formula, that an individual would still be considered a resident, for the current year, based on the number of days in the prior year(s) alone. If the taxpayer does not have at least 31 days of presence then he would not be a U.S. tax resident for the current year. It does not matter how many days of physical presence he may have had in the prior years.
Take the number of days in the current year plus the number of days in the first prior year times 1/3 plus the number of days in the second prior year times 1/6. Any fractional days resulting from the above calculations will not be rounded to the nearest whole number. As such the formula is
Total number of days = Current year + (First prior year x 1/3) + (Second prior year x 1/6)
For example, let’s assume that Bob, an alien individual, is present in the United States for 122 days in the current year. He was present in the United States for 122 days in the first preceding calendar year and for 122 days in the second preceding calendar year.
In determining Bob’s status for the current year, we count all 122 days in the United States in the current year plus 1/3 of the 122 days in the United States in the first preceding calendar year (40 2/3 days) and 1/6 of the 122 days in the United States during the second preceding calendar year (20 1/3 days).
The total of 122 + 40 2/3 + 20 1/3 equals 183 days. Bob meets the substantial presence test and is a resident alien for the current year.
What are my options?
Assuming that the individual has become a U.S. resident under the substantial presence test AND that he remains a factual resident of another country (or countries), he may not wish to be treated as a U.S. resident for U.S. tax purposes.
An individual shall not be treated as meeting the substantial presence test with respect to any current year if—
- such individual is present in the United States on fewer than 183 days during the current year, and
- it is established that for the current year such individual has a tax home in a foreign country and has a closer connection to such foreign country than to the United States.
Individuals who have meet the substantial presence test and are making the closer connection argument need to file Form 8840, “Closer Connection Exception Statement for Aliens” with the IRS by the appropriate due date.
Reliance on tax treaty.
If the individual has exceeded 182 days during the current year, the closer connection exception will not apply. The only option would then be to rely on the residency tie-breaker rules contained in the relevant Income Tax Convention. The issue here is that reliance on a tax treaty does NOT alleviate the individual of any potential filing obligations as a U.S. resident. There are substantial penalties for not filing any required information returns.
These individuals would file Form 1040NR, “U.S. Nonresident Alien Income Tax Return” along with Form 8833, “Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)” disclosing their reliance on the treaty residency tie-breaker rules.
Individuals MUST monitor their days of U.S. physical presence in order to minimize the risk of being considered a U.S. resident.
How will the U.S. government know how many days I was in the U.S?
A foreign national or alien entering the U.S. is generally required to present a passport. Depending on the country of which they are resident, a valid visa issued by a U.S. Consular Official may also be required.
The Visa Waiver Program allows foreign nationals from certain countries to be admitted to the U.S. under limited conditions and for a limited time without obtaining a visa. The foreign national must arrive on an approved carrier (if coming by air or sea), staying no more than 90 days, for pleasure/medical purposes/business, and be able to prove they are not inadmissible. The foreign national, however, is still required to have a passport.
When you are interviewed by the U.S. border official, they will scan a copy of your passport into their computer system. There is currently no requirement for your passport to be scanned when leaving the U.S. If you are, however, entering Canada, the Canada Border Service Agency (CBSA) will scan your passport and that information is shared with the United States.
Interested readers should get a copy of their passport and type https://i94.cbp.dhs.gov into their web browser. This will bring the U.S. Customs and Border Protection’s “I-94 Official Website” up. Click on “View Travel History” and enter your information. You may be surprised on what information is there.
Though not perfect and not a “legal” source of information the site does disclose the dates of entry and in many cases, the date of departure. You can run but you can no longer hide! It would not surprise us in that, in the future, this information can be shared with the IRS.
Cadesky U.S. Tax is a full service advisory and compliance firm. We monitor U.S. tax news that may be of interest to our readers and share our thoughts in U.S. Tax Tips. If you require our assistance please do not hesitate to reach out to us.