~ Immigration Tax Planning ~

Residence for U.S. Income Tax Purposes

The United States generally taxes its citizens and its residents on all of their worldwide income. On the other hand, non-resident non-citizens are taxed only on their U.S. source income and on foreign income that is effectively connected with a U.S.-based trade or business. For this reason, it is very important to determine whether a non-citizen is a resident for U.S. income tax purposes.

A non-citizen will generally be a resident if any of the following is true for a particular tax year:

1. the person has been admitted as a permanent resident of the United States (often referred to as a "green card" holder, although the residency permits are no longer green)
2. the person has been physically present in the United States for a sufficiently long time during the current year and the prior two years under the "substantial presence" test
3. the person is physically present in the United States at the end of one tax year, is not a U.S. resident under the other two tests for that tax year, but is a U.S. resident under one of the other two tests for the next tax year, and elects to be a U.S. resident for the earlier year

Lawful Permanent Resident

A person who has been admitted as a lawful permanent resident (i.e. a "green card" holder) is treated as a U.S. resident for the year in which the "green card" is issued and for all subsequent years until lawful permanent resident status is rescinded or abandoned. Be careful, once you have a "green card" you are a U.S. resident regardless of where you live during any subsequent tax year. That means that even if you move back to your country of citizenship, you will continue to be a U.S. resident (and therefore subject to U.S. tax on your worldwide income) unless your U.S. permanent resident status is administratively or judicially rescinded or deemed abandoned. Thus you cannot just decide by yourself to stop being a U.S. resident for tax purposes, you tax status will continue to be tied to your immigration status while you hold your "green card".

Substantial Presence Test

All non-U.S. citizens who have NOT been admitted as permanent residents and who are physically present in the United States for 31 days in any year must test their residency status under the substantial presence test. Under this test, a non-citizen is a U.S. resident for income tax purposes if he or she has been physically present in the United States on at least 183 days during the current year and the two previous years. For purposes of this test, the number of days that a non-citizen is present in the United States is calculated as follows:

• each day of presence in the current year counts as one full day
• each day of presence in the first preceding year counts as one-third (1/3) of a day
• each day of presence in the second preceding year counts as one-sixth (1/6) of a day

For example, if the person was present 122 days in the current year and each of the last two years, the number of days of presence under the formula would be 182 (122 + 40 + 20), so the person would not be a U.S. resident under the substantial presence test. On the other hand, if the person was present 123 days each year for three years, the person would be a U.S. resident for the third year (123 + 41 + 20 = 184).

The substantial presence test can apply in a broad range of circumstances, and can be a factor for non-citizens who come to the United States under many different visa categories. It is the general rule for testing U.S. residency for income tax purposes, and any visa-holder who has substantial wealth outside the United States should keep this rule in mind throughout their stay here.

Exceptions to Substantial Presence Test

There are two major exceptions to the general rule of the substantial presence test.

Excluded Days

The first of these is that many days in which a person is actually physically within the United States do not count for purposes of testing against the 183 day threshold. These excluded days generally include the following:

• days in which the person has full-time diplomatic or consular status
• days in which the person is prevented from leaving the United States because of a medical condition
• days in which the person is in transit between two points outside the United States
• days in which the person is a full-time employee of a designated international organization (such as the United Nations)
• days in which the person is a teacher or trainee admitted under section 101(a)(15)(J) of the Immigration and Nationality Act
• days in which the person is a student admitted under sections 101(a)(15)(F), (J) or (M) of the Immigration and Nationality Act
• days in which the person is a professional athlete temporarily present in the United States to compete in a charitable sports event
• days in which a regular commuter resident in Canada or Mexico commutes to and from employment within the United States

If a person can exclude enough days, the person will not be treated as physically present for 183 days during the three year period, and thus will not be a U.S. resident under the substantial presence test.

Closer Connection Exception

Even if a person cannot exclude enough days to avoid being a U.S. resident under the substantial presence test, the person may be able to avoid U.S. residency for income tax purposes by qualifying as a resident of another country under the "closer connection" exception. To qualify under the closer connection exception, the non-citizen must be able to prove all of the following:

• the person was not physically present in the United States for 183 days or more during the current year (ignoring days of presence in prior years)
• the person's principal place of business (or principal residence, if the person does not have a principal place of business) is outside the United States
• the person has a closer connection to one foreign country - the one in which such person's principal place of business (or principal residence if no place of business) is located - than to the United States

A non-citizens shows that he or she has a closer connection to another country by comparing the number and type of contacts that the person has with the United States and with the other country. Important factors to be considered include the following:

1. the location of the person's permanent home
2. the location of other members of the person's family
3. the location of the person's (and his or her family's) important personal belongings such as automobiles, furniture, clothing and jewelry
4. the location of the person's current affiliations with social, political, cultural or religious organizations
5. the location where the person currently conducts routine personal banking activities
6. the jurisdiction in which the person holds a driver's license
7. the location where the person conducts business activities other than the principal place of business
8. the jurisdiction in which the person votes
9. the country of residence the person designates on forms and documents

If the majority of these factors point to the other country, then the person has a closer connection with the other country and, if the other requirements are satisfied, is not a U.S. resident for income tax purposes even though physically present in the United States for enough days to trigger U.S. residency under the substantial presence test.

Coordination with Income Tax Treaties

A very important consideration for any potential immigrant to the United States is the provisions of any applicable income tax treaty which the United States may have with the immigrants country of citizenship. Such a treaty may provide important income tax benefits to the immigrant regardless of residency status. Moreover, it is possible that the treaty would enable the person to avoid being a U.S. resident for income tax purposes notwithstanding that the person qualified as a U.S. resident under either the lawful permanent resident ("green card") or substantial presence tests.

To claim the benefit of non-resident status under an income tax treaty, the person must timely file a return on Form 1040-NR, compute his or her U.S. income tax liability as a non-resident alien, and attach a statement to the Form 1040-NR indicating the facts relied upon to justify being a non-resident under the treaty and the nature and approximate amount of income that would be subject to U.S. income tax if the person were treated as a U.S. resident.

Conclusion

The discussion above clearly indicates that determining whether a particular person is a U.S. resident for income tax purposes can be a very complicated task, especially if the person is physically present in the United States for a substantial period and has not been admitted as a lawful permanent resident. In that situation, a little bit of careful planning may make the difference between being a U.S. resident taxed on worldwide income or being a non-resident alien taxed only on U.S. source income and income effectively connected with a U.S. trade or business. For an individual with a significant amount of assets located outside the United States, that difference can have enormous consequences.

Richard S. LeVine, Esq.
157 Church Street, 19th Floor
New Haven, CT 06510
Tel: 203-789-1320 Fax: 203-785-8127
Email: info@taxhoncho.com