Under US tax laws, any individual with a “substantial presence” in the United States runs the risk of being classified as a US person for tax purposes. Those who are physically present in the United States for a long enough time may find themselves owing taxes on their worldwide income to the IRS even if they are neither a US citizen nor a green card holder, and even if they earn no income from US sources.
The Substantial Presence Test
The criteria often cited for meeting the substantial presence test is residing in the US for more than 182 days in a given calendar year. This is very misleading, as the actual calculation used by the IRS is more complicated and looks at US residency over a three-year period. An individual has a “substantial presence” in the US for a particular calendar year (e.g., the “current” calendar year) if the sum of the following equals 183 days or more:
1) The number of days they were present in the US during the current calendar year;
2) One-third the number of days they were present in the US during the previous calendar year;
3) One-sixth the number of days they were present in the US during the second previous calendar year;
In addition, the individual must have spent at least 31 days in the United States in the current calendar year.
This means that a person who resides in the US for 121 days each year, for three consecutive years, would fall just short of the substantial presence criteria (121 + 40.33 + 20.16 = 181.49 days). Any more than that risks being classified as a US person, or more specifically what is called a “resident alien”. Helpful guidance from the IRS can be found here.
Tax Obligations of Resident Aliens
For US tax purposes, a resident alien is treated in the same manner as any US citizen or green card holder. They are taxed on their worldwide income and face complicated tax obligations and reporting requirements.
Resident aliens are required to file US income tax returns (Form 1040, 1040A or 1040EZ ) reporting all income sources. They may also be required to file Form 8938 – Statement of Specified Foreign Financial Assets as well as FinCEN Form 114 – Report of Foreign Bank and Financial Accounts (“FBAR”), which carry significant penalties if not submitted in a timely fashion. FBAR penalties in particular can be as high as $10,000 per year for mere negligence (as compared to a “willful” non-filing) with regard to each unreported non-US bank or other financial account.
Exceptions to the Substantial Presence Test
Meeting the substantial presence test does not automatically mean being classified as a resident alien and facing all associated tax obligations. Those staying in the US on certain nonimmigrant visas such as students and certain teachers and trainees are generally exempt, provided they comply with all requirements of their visa and are not found to be in violation of any US immigration laws. This exemption may extend to nonimmigrant spouses and children of those holding these visas, if they are dependents who share the same household and the children are under 21 years of age. You can read more about these special exemption categories of individuals in my earlier blog posting.
After five years, the exemption provided by nonimmigrant visas may expire unless additional conditions can be satisfied, including the IRS examining the facts and circumstances of the case and determining that the visa holder has no intention to reside permanently in the US.
Other exceptions include those who are in the United States as employees of foreign governments or certain international organizations. An exception also exists for individuals who have been forced to remain in the US due to a medical condition, provided, most importantly, that the condition arose while the individual was already in the US. Thus, an foreign individual coming to the US for prolonged treatment for a pre-existing medical condition cannot avail himself of this exception. For all of these special cases, Form 8843 – Statement of Exempt Individuals and Individuals with a Medical Condition must be filed.
The Closer Connection Exception
Even if none of the above exemptions apply, an individual who has overstayed his welcome from a tax perspective may still find relief. He may be treated as a nonresident alien after meeting the substantial presence test, provided it can be determined that the individual has a so-called “closer connection” to a foreign country than to the US.
The initial criteria for establishing this connection is that the individual maintains a “tax home” in the foreign country, and has not resided in the US for 183 or more days during the current calendar year alone. They may also not have applied to become a lawful permanent resident of the US during that same year. Beyond that, the IRS will examine the facts and circumstances of each case to determine whether the individual has closer ties with the foreign country than with the United States. Some of the factors considered include the location of a person’s permanent home (which may be rented rather than owned, but must be available for use at all times), where their family members reside, where they keep their personal belongings, and where they conduct their business.
Claiming a closer connection with a foreign country requires filing Form 8840 – Closer Connection Exception Statement for Aliens. This form must be filed by the 15th of June the year after a given tax year in order to be valid for that tax year. Those who successfully claim the closer connection exception will remain classified as nonresident aliens, and can avoid facing tax obligations on their non-US income.
More information on how the Closer Connection Exception is determined can be found on the IRS page here.
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