When Led Zeppelin sang about “Going to California,” they were probably blissfully unaware of the potential tax consequences on this side of the pond.
If you have come to the U.S. to live for business reasons, an extended vacation, to avoid high tax rates in your home country, or for a host of other reasons, you need to be aware that you may be liable for U.S. taxes.
Likewise, if you are a U.S. taxpayer who has relocated to another country, you may still have to pay U.S. taxes. The IRS has specific guidelines (tests) to determine whether you owe taxes and how much. This is primarily contingent on how long you lived here during the current tax year.
There are layers of complications to this, such as if the U.S. has a treaty with the country in question, and the terms of the tax treaty between the two countries — if one exists. Additionally, rules exist for green card holders, foreign students and more.
International tax issues are very complex and if errors are made, the penalties can be quite steep. That is why I encourage you to meet with me if you have any doubt as to whether you could be classified as a “U.S. person” in the eyes of the IRS.
Are You a U.S. Person or Not?
The first two steps that you must take in order to figure out whether you have a filing requirement in the U.S. is to:
- Determine whether you are considered a U.S. person or a foreign person for tax purposes, as different rules apply to each of these two groups of people
- Determine whether any of your sources of income must be taxed. This chapter will discuss how the U.S. defines U.S. taxpayers, with an emphasis on how the definition is applied at the individual level.
The definition of a U.S. person, for tax purposes, includes U.S. citizens, residents, partnerships, corporations, estates and trusts. (See 26 U.S. Code § 7701(a)(1); See also the IRS’ page on Classification of Taxpayers for U.S. Tax Purposes).
On the other hand, foreign persons include foreign corporations, partnerships, trust, and estates, as well as nonresident aliens and any other persons who do not fall under the definition of U.S. person. (See Classification of Taxpayers for U.S. Tax Purposes).
It will be important to keep these definitions in mind as you navigate the contents of this book.
In general, any individual who is a U.S. citizen or a resident will be deemed a U.S. taxpayer. When it comes to taxes, the definition of residency does not only include lawful permanent residents. Rather, certain individuals who meet the “substantial presence” test are also considered residents for tax purposes.
Substantial Presence Test
The “substantial presence” test is satisfied when an individual has spent 31 days in the United States for the current year AND 183+ days in the last three years (including the current year). All the days spent in the U.S. during the current tax year, one-third of the days spent in the country in the year before the current year and one-sixth of the days spent in the country two years before the current year will count towards the 183 day requirement.
Any days in which an individual spends in the U.S. temporarily as a either a “foreign government-related” individual under an “A” or “G” visa (not including “A-3” or “G-5” visas), a teacher or trainee holding a J or Q visa, a student with a F," "J," "M," or "Q" visa, or a professional athlete competing in a charitable sporting event will not count towards the 183 day threshold.
See the IRS’ Substantial Presence Test.
Exception for Those Having Liability Under the “Substantial Presence Test”
However, not all individuals who satisfy the residency requirements will have to pay U.S. taxes. If an individual either has closer connections to another country, they may be exempt from paying U.S. taxes despite having met the previously mentioned criteria for the “substantial presence” test.
When determining whether you have a closer connection in another jurisdiction, the IRS will look at various factors pertaining to the individuals’ specific circumstances such as where their home, belongings and family are located and the jurisdiction in which they have registered their car and have been issued an ID, among other factors. (See Closer Connection Exception to the Substantial Presence Test).
U.S. citizens, lawful permanent residents, and any individuals who applied for lawful permanent residency or had an application for residency pending do not qualify for this exemption.
Furthermore, in order to qualify for this exception, the individual must not have spent 183 or more days in the United States and must have had a tax home in another in the foreign jurisdiction for the entire tax year for which they are seeking the exemption.
There is also an exception to the “substantial presence” test that applies specifically to foreign students, in recognition of the fact that most foreign students would be in the United States for more than 183 days in the year.
A foreign student who 1) does not intend to reside permanently in the United States 2) has substantially complied with immigration laws with respect to their status 3) has not taken steps to adjust their nonimmigrant status and 4) has closer connections to a jurisdiction other than the United States may qualify for this exception.
Treaty Country Exception
Additionally, certain green card holders and individuals classified as residents under the substantial presence test may also be exempt from paying U.S. taxes on their income due to a treaty that may be in effect between the U.S. and another country in which they are deemed residents.
While there are various countries with which the U.S. has tax treaties, these treaties will allow individuals who are considered residents of two countries to be reclassified as residents of only one for tax purposes.
The language in the treaties will vary from country to country. However, the reclassification process would typically be done by selecting the jurisdiction in which the individual has their permanent abode or, when there are permanent abodes in both jurisdictions, determining where the individual has their “center of vital interests.”
If no “center of vital interest” or permanent abode is discernible, the next question would be where the individual has a “perpetual abode.” If the inquiry into the taxpayer’s “perpetual abode” yields no answers, then the individual’s nationality will be the determining factor.
For a list of the current tax treaties between the U.S. and various countries, as well as their full text, refer to the IRS page on United States Income Tax Treaties - A to Z.
While these provisions will relieve the individuals from having to pay U.S. taxes, any individual looking to benefit from the treaty provisions will still have to fill out Form 1040NR and Form 8833.