Overview of US Income Tax Residency Rules

Florida is experiencing records levels of growth[1]and most of that growth is from non-US persons migrating to the state from abroad. 

This article is a brief overview of some of the US income tax rules applicable to when a migrating individual is treated as a US taxpayer (meaning a US income tax resident or US citizen). 

US income tax residents and US citizens are taxed on their worldwide income and subject to reporting requirements concerning their worldwide financial assets (which include interests in closely held foreign businesses, bank accounts, brokerage accounts, foreign stocks or mutual funds owned outside of a US brokerage account, and other foreign financial assets).  The foregoing reporting regime makes determining a migrating individual’s US tax status critical to lowering their global effective tax rate.

While the definition of a “US citizen” is clear to most individuals (you are either born in the US or naturalized), the definition of a “US income tax resident” is not.  Generally, an individual may become a US income tax resident under one of two tests[2]:

1.     Permanent residence test (commonly referred to as the “Green Card” test)[3]; or

2.     The substantial presence test (hereafter, referred to as the “SPT”)[4]

Permanent Residence Test

All lawful permanent residents of the US are considered US income tax residents.  In recent years, and we expect the trend to continue, individuals are often obtaining US green cards by making significant investments into the US and applying for permanent lawful status via the US EB-5 immigration program. Once an individual receives a green card and is present in the US they are considered a US person.[5] Therefore, in the initial year an individual becomes a US income tax resident under the permanent residence test they will generally break the taxable year into two portions (1) the portion of the year they are considered a non-resident, and (2) the portion of the year they are considered a US tax resident.

An individual may be able to be treated as a nonresident for purposes of paying US taxes on worldwide income (but not for purposes of filing US informational disclosure returns) where the individual is treated as an income tax resident of a country with which the US has an income tax treaty and files a Form 8833 notifying the IRS of their reporting position.[6]  Various treaty tie-breaker rules apply in making the determination of which country an individual is an income tax resident of. 

Substantial Presence Test

An individual satisfies the SPT if the individual is physically present in the United States for at least 31 days during the current year and at least 183 days for the three year period ending on the last day of the current year using a weighted average formula as follows:

(a)             number of days present in the current year; plus,

(b)            1/3 of the number of days present in the first preceding year; plus,

(c)             1/6 of the number of days present in the second preceding year.

 Note that fractional days are not rounded up or down to the nearest whole number.

For SPT purposes, an individual is treated as being present in the U.S. on any day he/she is physically present in the country, at any time during the day. However, there are certain exceptions to this rule. The exceptions are beyond the scope of this article. 

The SPT is automatically met if the individual is present in the US in the current calendar year for 183 days or more.

Once an individual satisfies the SPT, their residency starting date is the first day of the calendar year the individual is present in the US.[7]

Residents of non-treaty countries cannot rely on the treaty tie-breaker exception that is available to residents of treaty countries. However, even if an individual is a US tax resident under the SPT they may be deemed to be a non-resident of the U.S. for income tax purposes, if the individual can show a closer connection to a foreign country.[8] However, for this exception to apply (i) the individual must be present in the US in the current calendar year less than 183 days, and (ii) the individual must be considered to have a tax home in a foreign country and a “closer connection” to that foreign country than to the US.  In order to claim this exception the individual must file Form 8840 with the IRS. A variety of factors are considered when determining whether an individual qualifies for the closer connection exception including[9]:

i.               The location of their permanent home;

ii.              The location of their immediate family members;

iii.            The location of their principal place of business;

iv.             Where their vehicles, furniture, jewelry and other personal property are located;

v.              Where their personal bank accounts are;

vi.             What country or states they hold a driver’s license in;

vii.           Where the individual votes for political office;

viii.          Where their social network, community ties and religious affiliations are;

As the foregoing brief discussion illustrates, the determination of the proper reporting classification for an individual spending more than an insignificant amount of time in the US is complex and requires consideration of many factors. If you have spent significant time in the US, we recommend you consult competent legal counsel. Barbosa Legal has attorneys who specialize in the area of taxation and can advise you with any tax matters.

[1] https://www.floridatrend.com/article/25490/919-new-floridians-every-day

[2] See also IRC 7701(b)(1)(iii) regarding an individual’s ability to make a first year election to be treated as a US income tax resident.

[3] IRC 7701(b)(1)(A)(i)

[4] Id.

[5] IRC 7701(b)(2)(A)(ii)

[6] IRC 7701(b)(6)(B)

[7] IRC 7701(b)(2)(A)(iii)

[8] IRC 7701(b)(3)(B)(ii)

[9] Treas. Reg. 301.7701(b)-2(c)(1)

TaxMaria Moller