If you travel frequently to—or are considering moving to—the US, it's essential to understand US tax residency and how to manage tax and reporting obligations effectively to avoid complications.
The tax code considers any persons who aren't US citizens as US income tax residents if they meet the Green Card Test or the Substantial Presence Test. The GCT applies to green card holders, or individuals who have been granted permanent residency in the US. Residency starts on the first day of the calendar year when the green card holder is physically present in the US while holding a green card, or on the date the SPT is satisfied, if earlier.
The SPT applies to individuals who are neither US citizens nor green card holders, if the individual is present in the US for 31 days during the current tax year, and if the sum of the days present in the current tax year, plus one-third of the days in the preceding tax year, and one-sixth of the days present in the second tax year equals 183 days.
Even if the SPT is satisfied, US income tax residency may be avoided under the closer connection exception. This exception considers you a non-US resident for income tax purposes if you have a tax home in a foreign country with which you have a closer connection, such as a permanent home, family members, or social and political ties.
A tax treaty with the US can affect whether an individual is considered a US tax resident even if the individual meets the GCT or SPT under the treaty's tie-breaker rules. However, long-term green card holders who use treaty tie-breaker rules to avoid US income tax residency will be subject to US exit tax if they would be characterized as "covered expatriates" under the income and asset tests of the tax code.
How to Avoid US Income Tax Residency
If you're not a US citizen or resident, try to plan and structure your move to the US in a way that minimizes your tax exposure, such as by being present in the US on a non-immigrant visa or carefully planning how many days you spend in the US during a particular year.
There may be tax benefits to being classified as a US tax resident even if you don't meet the GCT or SPT. Electing to be treated as a US income tax resident entitles you to the same helpful deductions and credits available to US citizens and permanent residents. However, this election shouldn't be made without careful coordination between your tax advisers.
Green card holders should plan the decision to give up permanent residency status carefully. Giving up your green card could result in the imposition of the US exit tax, and failing to follow the procedures for officially giving up your green card could result in continued US tax liability.
Even if you're a non-tax resident under the SPT and GCT, note the good and bad news below.
All US source income will be subject to income tax in the US, with certain exceptions. For example, most income tax treaties contain provisions permitting taxation of income by non-resident artists and athletes in the country it is earned. Thus, even with careful planning, income from actor or athlete services performed in the US may still be subject to income tax.
However, royalty and pension income generally won't be subject to US income tax if you remain a non-US resident for income tax purposes.
If You Become a US Income Tax Resident
Spending a considerable amount of time or living outside the US is irrelevant. Once you obtain US tax residency under the GCT, you must report all your worldwide assets and pay taxes on your worldwide income for as long as you hold your green card. The same rule applies for any tax year in which you satisfy the SPT.
Review whether the US has a tax treaty with your jurisdiction. If an enforceable treaty exists, it may prevent double taxation under a treaty tie-breaker rule or preferential rate. However, as noted above, this solution could have exit tax consequences for long-term green card holders.
If no treaty exists, foreign tax credits are another strategy to mitigate your tax exposure. The tax code allows you to claim a credit for foreign income taxes paid on income earned outside the US. This credit can offset your US tax liability on the same income. Consider how your non-US structures and entities will be characterized and taxed by the US. Not all entities, trusts, and foundations will be characterized and taxed the same way as they are in the country in which they were formed.
Upon acquiring US tax residency, you must file your federal income tax return for the corresponding year. You may also be required to report any foreign assets under the Report of Foreign Bank and Financial Accounts and the Foreign Account Tax Compliance Act.
Residency Implications and Challenges
Without an income tax treaty to mitigate double taxation, income tax residency in two countries may lead to double taxation. This can result in reduced income for the individual unless the domestic statutory crediting in the US and the foreign jurisdictions are aligned.
Income tax residency in the US requires filing US federal income tax returns and possibly state-level returns. If you remain a tax resident in a foreign jurisdiction, it may require return filing in that jurisdiction as well, which can be difficult and costly.
Differing reporting requirements in the two countries exercising taxing jurisdiction may lead to audits and onerous penalties if the filing and reporting of income isn't done properly in both jurisdictions.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Originally Published by Bloomberg Tax
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.