When US Tax Residency Is Not So Simple

By: Ashley Kiel

In general, for federal income tax purposes, individuals who are U.S. persons (citizens or resident aliens) are subject to tax on their worldwide income. Individuals who are not U.S. persons are usually subject to tax just on their U.S.-source, effectively-connected income. These rules sound like they should be very black and white. When dealing with US taxes, however, unfortunately it is often not so simple.

When guiding taxpayers through the tax year and their tax returns, it can be fairly easy for tax professionals to advise on some of the general principles. However, when certain tax laws depend on the facts and circumstances, the outcomes are fundamentally more complex. In particular, U.S. residency regulations can be challenging when taking into account the many exceptions to the general tax laws.  It is very important to work with a professional who is able to skillfully interpret the tax laws, and in many cases, tax treaties, to ensure an appropriate outcome for their client.

People who are not residents of the U.S., or “aliens”, are considered nonresidents of the U.S. unless they qualify as residents under one of two tests: the substantial presence test, or the Green Card test. The substantial presence test measures the number of days the alien is physically present in the U.S. over a three-year period. An alien meets this test by being physically present in the U.S. for at least 31 days in the current year and 183 days using a calculation for the last three-year period. Under the Green Card test, aliens are considered residents if they are lawful permanent residents of the United States at any time during the calendar year. Lawful permanent residents are individuals who have been granted the privilege of residing in the U.S. through the Green Card immigration process.

Beyond the rules mentioned above, the question of whether exceptions apply is largely a gray area, determined by a factor test. For example, an individual who meets the substantial presence test could still be treated as a nonresident if they qualify for the “closer connection” exception. The three closer connection requirements that an individual must satisfy are: 1) must be present in the United States for less than 183 days in the current year, 2) maintains a tax home in a foreign country during the current year, and 3) has a closer connection to the foreign country in which the individual maintains a tax home other than the United States. An alien will be deemed closer in connection with a foreign country if the alien or IRS establishes that the individual has maintained more significant contacts there. Facts and circumstances that may determine that the individual has more significant contacts in the foreign country may include the location of the individual’s personal belongings, social connections, school and religious connections, the location of the jurisdiction in which the individual votes, the location of charitable organizations to which the individual contributes, and other factors which solidify their position.

Generally, the federal tax residency rules for individuals are fairly straight-forward. However, the gray area of whether exceptions are applicable is extremely important to research and discuss with your tax advisor in order to determine proper residency and tax compliance.