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U.S. Resident or Non-resident?

Chris McNally

From Chris McNally, PP&Co Senior Accountant

Given the robust global market, it is important for foreign individuals to understand the tax filing requirements within the United States, and the impact their residency status has on taxation. The reporting requirements for foreign individuals are complex and nuanced. This article provides general rules regarding residency determination for income tax purposes, but is not intended to cover all situations involved in this matter and required reporting.

The Internal Revenue Service (IRS) has established two tests to determine individuals’ residency status for income tax purposes in the United States. The tests are known as the “green cars test” and the “substantial presence test.” An individual is considered to be a U.S. resident for income tax purposes if either test is met. There are exceptions to the rules, as well as elections available where an individual’s status may be changed from a resident to a non-resident, or from a non-resident to a resident, for income tax reporting purposes.

The green card test is met if, during any time of the year, the taxpayer is a lawful permanent resident (a green card holder) or a U.S. citizen. Generally, for this test, tax residency begins on the first day he/she is physically present in the United States as a green card holder. The residency remains for all years they hold a green card or citizenship. Special reporting rules and exit tax may apply if the green card or citizenship is relinquished.

The substantial presence test is a calculation based on the number of days one is physically present in the United States, absent a green card or U.S. citizenship status. There are different types of visas and exceptions for some visa types. Generally, substantial presence is established if one is in the U.S. for at least 31 days during the current year and for 183 days during a 3-year period, including the current calendar year and the two years immediately preceding the current year. The number of days is calculated by adding all days one is physically present in the U.S. in the current year, 1/3 of the days in the preceding year and 1/6 of the days in the 2nd preceding year. Seem confusing? Here’s an example to clarify:

You are in the U.S. for the following:
120 days in 2016 (count 120 days – all the days)
150 days in 2015 (count 50 days – one-third of 150 days)
120 days in 2014 (count 20 days – one-sixth of 120 days)

Therefore, you are considered to be in the U.S. for 190 days (120 + 50 + 20) based on the substantial presence test.

The non-resident alien may claim certain exceptions to be considered a non-resident for income tax purposes, even though they meet the substantial presence test. For example, the individual may claim closer connection exception if certain requirements are met in order to be considered a non-resident.

The individual’s residency status is the determining factor for deciding if an individual is subject to U.S. income taxation and what should be reported on the income tax returns (and other information returns if applicable). U.S. residents (for income tax purposes) are taxed on their worldwide income and must report worldwide foreign financial assets. Conversely, non-residents of the U.S. (for income tax purposes) need only report certain income sourced from the U.S. and are not required to report foreign financial assets.

As mentioned, there are certain exceptions to the general rules. One exception may be available when there’s an effective tax treaty between the U.S. and a foreign country under whose law the individual can also be considered a resident for income tax purposes. The U.S. has income tax treaties with many foreign countries. The treaties often contain articles regarding residency determination. The treaties may also address other aspects of income tax, such as withholding tax rates on different types of income. A note of caution – you must very carefully review the tax treaty when relying upon its residency article for determining residency status.

It is also possible for an individual to be both a resident and nonresident in the same year. In these scenarios, the taxpayer is considered to have dual status. This circumstance is common in the year the individual arrives in, or departs from, the United States. Under these circumstances, the individual would file a dual status tax return, which includes both resident and nonresident periods. Resident and nonresident income and foreign financial asset reporting rules apply for each corresponding period, respectively.

These are general rules regarding the residency determination in a nutshell. The actual determination should be done based on the individual’s specific situation. The rules are complex and failure to comply with the reporting requirements may subject taxpayers to hefty penalties. We are here to help if you have any questions or concerns, please feel free to contact us at (408) 287-7911 or info@ppandco.com.