The primary issue when determining the U.S. income tax implications of a foreign individual is to determine whether he or she is a U.S. resident or nonresident alien. Similar to U.S. citizens, resident aliens are taxed on their worldwide income, whereas nonresident aliens are only taxed by the United States on their U.S. source income.
Two tests are used to determine U.S. resident alien status. The first is the green card test. If an alien has a U.S. green card, they are considered a U.S. resident and taxed by the United States on their worldwide income.
The second test is substantial presence. This test requires an accurate record of days in the United States, whether it be for business or holiday, for the current year and the prior two years. The individual must be present in the United States for a total of 183 days over the three-year period to be considered a resident alien. The formula values each day of the current and prior two years differently. Current-year days are considered at face value. The first-prior-year days are valued at 1/3 of the total in that year; the second-prior-year days have a 1/6 value. For example, a common tax planning tool is for a taxpayer to keep his or her U.S. day count at no more than 120 days per year. So, if the day count was 120 for each year for 2017, 2016, and 2015, the total day-count value would be 180 (120+40+20). Accordingly, the taxpayer would not be considered a U.S. resident alien because he or she did not meet the 183-day count.
There are other important planning issues for alien individuals before they come to the United States. For example, there can be significant estate tax issues if an alien dies during U.S. residency. Prior to the U.S. residency, he or she might be able to transfer valuable assets to trusted non-U.S. nonresident alien family members. Further, the United States determines basis in an asset using U.S. tax rules that are applied as if the person was a resident when they acquired the assets. There is no automatic step-up of assets to fair market value when U.S. residency begins. However, there are planning techniques to do a basis bump that can be undertaken to step up the basis of assets prior to immigration and to clear out the preimmigration gain. Many U.S. resident aliens are surprised when they dispose of an asset and find that preimmigration gains are taxed by the United States.
If an individual has a closer connection to their foreign home, and are in the United States for 183 days or less during the year, they may be able to elect out of U.S. resident alien status. A closer connection to another country may be established if the individual maintains a tax home in a foreign country during the year and maintains more significant contacts with the foreign country than the United States. Facts and circumstances to be considered include the following:
- Location of permanent home
- Location of your personal belongings
- Current social, cultural, or religious affiliations
- Jurisdiction of your driver’s license
- Jurisdiction in which you vote
- Charitable organization to which you contribute
To claim closer connection, the person must file Form 8840 and attach it to his or her U.S. federal income tax return.
The year of arrival to and the year of departure from the United States is considered to be a dual-status year. Part of the year is filed as a U.S. nonresident and part of the year is filed as a U.S. resident. U.S. residency tends to start the first day the alien is present in the United States. There is a less-than-10-day exception. If an alien spends less than 10 days in the United States prior to U.S. residency, those days are not counted in establishing when U.S. residency begins. To be considered a U.S. resident in the last year, the individual must have been in the United States at least 31 days.
Prior to leaving the United States, resident alien taxpayers must file a 1040-C or Form 2063 to obtain a certificate of compliance, also known as a “sailing permit.” The IRS provides various examples in Publication 519 of those who would be required to obtain a certificate and those who would not. Taxpayers cannot obtain a certificate more than 30 days from their departure date, and should try to get it at least two weeks prior. The 1040-C is not a tax return, so an annual return may still be required.
A tax treaty may override the Internal Revenue Code. Each treaty is unique and should be read and reviewed carefully. If a treaty override provision is taken (for example, using the residency tiebreaker clause) it likely will need to be disclosed on a U.S. tax return. Failure to disclose a treaty-based position leads to its invalidation. It is important to get quality tax advice from the foreign jurisdiction that the U.S. resident alien came from. What may be good from a U.S. tax perspective may produce horrible tax results on the foreign side, and vice versa.
Christopher R. Cicalese, CPA, is a manager with Alloy Silverstein in Cherry Hill, N.J. He can be reached on Twitter @AthleteCPA or at firstname.lastname@example.org.
Michael L. Engleman, CPA, is an associate partner with Alloy Silverstein. He can be reached at email@example.com.