Closer Connection Exception to the Substantial Presence Test

Closer Connection Exception to the Substantial Presence Test: The U.S. follows a worldwide taxation model. That means the U.S government taxes U.S persons on their worldwide income. Foreign nationals who reside in the U.S. and are neither permanent residents nor U.S. citizens may still be subject to worldwide tax and reporting when they meet the IRS substantial presence test. But, if the person qualifies for the closer connection exception, they may avoid the worldwide taxation rules.

U.S. person “individuals” are generally broken down into four (4) main categories:

- - U.S. Citizen
  - Legal Permanent Resident
  - Foreign National who meets the Substantial Presence Test
  - Former U.S. Person who did not expatriate correctly.

The third category above is the category impacted by the closer connection exception to the substantial presence test. And, with the IRS taking an aggressive position on issues involving foreign accounts compliance and unreported offshore income, compliance is crucial in order to avoid fines and penalties.

What is the Substantial Presence Test?

The Substantial Presence Test (SPT) is an IRS test developed to trap foreign nationals who are not otherwise subject to U.S. tax on their worldwide income, by deeming them “U.S. persons for tax purposes.” To complete the test, the foreign national calculates the number of days they have been in the U.S. for the past three (3) years. By meeting “substantial presence,” the individual is considered a U.S. person for tax purposes. But, even if a person meets substantial presence you may still escape U.S. tax claws by meeting the Closer Connection Exception and filing Form 8840.

Foreign National Residing in the U.S.

U.S. Persons are subject to U.S. tax on their worldwide income. For U.S. citizens and Lawful Permanent Residents, this does not (usually) come as a big surprise, but for non-permanent residents who are only temporarily in the U.S., to learn they are being taxed on their worldwide income and subject to all the onerous international information reporting requirements, it can come as a very unwelcoming surprise.

Example of Substantial Presence

Substantial Presence Test Calculation Example

As a non-US citizen and non-US green card holder, you are generally only required to pay tax on your “US Effectively Connected Income” (money you earn while working in the United States). However, if you qualify for the Substantial Presence Test, then the IRS will tax you on your WORLDWIDE income. The IRS Substantial Presence Test generally means that you were present in the United States for at least 31 days in the current year and a minimum total of 183 days over 3 years, using the following equation:

- - 1 day = 1 day in the current year
  - 1 day = 1/3 day in the prior year
  - 1 day = 1/6 day two years prior

Example A: If you were here 100 days in 2016, 30 days in 2015, and 120 days in 2014, the calculation is as follows:

- - 2016 = 100 days
  - 2015 = 30 days/3= 10 days
  - 2014 = 120 days/6 = 20 days
  - Total = 130 days, so you would not qualify under the substantial presence test and NOT be subject to U.S. Income tax on your worldwide income (and you will only pay tax on money earned while working in the US).

Example B: If you were here 180 days in 2016, 180 days in 2015, and 180 days in 2014, the calculation is as follows:

- - 2016 = 180 days
  - 2015 = 180 days/3= 60 days
  - 2014 = 180 days/6 = 30 days
  - Total = 270 days, so you would qualify under the substantial presence test and will be subject to U.S. Income tax on your worldwide income, unless another exception applies.

Closer Connection Exception to Substantial Presence

- - Even if you meet the substantial presence test, you can still be treated as a nonresident alien if you:
    - - Are present in the United States for less than 183 days during the year,
      - Maintain a tax home in a foreign country during the year (Refer to Chapter 28 of Publication 17for a discussion of the tax home concept), and
      - Have a closer connection during the year to one foreign country in which you have a tax home than to the United States (unless you have a closer connection to two foreign countries, discussed next).
  - For determining whether you have a closer connection to a foreign country, your tax home must also be in existence for the entire current year, and must be located in the same foreign country for which you are claiming to have a closer connection.

Closer Connection to Two Foreign Countries

- - - You can demonstrate that you have a closer connection to two foreign countries (but not more than two) if you meet all of the following conditions:
      - You maintained a tax home beginning on the first day of the year in one foreign country,
      - You changed your tax home during the year to a second foreign country,
      - You continued to maintain your tax home in the second foreign country for the rest of the year,
      - You had a closer connection to each foreign country than to the United States for the period during which you maintained a tax home in that foreign country, and
      - You are subject to tax as a resident under the tax laws of either foreign country for the entire year or subject to tax as a resident in both foreign countries for the period during which you maintained a tax home in each foreign country.

Establishing A Closer Connection

- - You will be considered to have a closer connection to a foreign country than the United States if you or the IRS establishes that you have maintained more significant contacts with the foreign country than with the United States.
  - In determining whether you have maintained more significant contacts with the foreign country than with the United States, the facts and circumstances to be considered include, but are not limited to, the following:
  - The country of residence you designate on forms and documents
  - The types of official forms and documents you file, such as Form W-9, Request for Taxpayer Identification Number and Certification, W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, or W-8ECI, Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States.
  - The location of:
    - - Your permanent home,
      - Your family,
      - Your personal belongings, such as cars, furniture, clothing, and jewelry,
      - Your current social, political, cultural, or religious affiliations,
      - Your business activities (other than those that constitute your tax home),
      - The jurisdiction in which you hold a driver’s license,
      - The jurisdiction in which you vote, and
      - Charitable organizations to which you contribute.
      - Note: It does not matter whether your permanent home is a house, an apartment, or a furnished room. It also does not matter whether you rent or own it. It is important, however, that your home be available at all times, continuously, and not solely for short stays.

When You Cannot Claim Closer Connection to a Foreign Country

- - You cannot claim you have a closer connection to a foreign country if either of the following applies:
  - You personally applied, or took other steps during the year, to change your status to that of a Lawful Permanent Resident, or
  - You had an application pending for adjustment of status to Lawful Permanent Resident during the current year.

Indications of Intent to Change Your Status

- - If you have filed any of the following forms, this is an indication that your intent is to become a Lawful Permanent Resident of the United States, and is an indication that you are not eligible for the Closer Connection Exception.
    - - Form I-508, Waiver of Rights, Privileges, Exemptions and Immunities
      - Form I-485, Application to Register Permanent Residence or Adjust Status
      - Form I-130, Petition for Alien Relative
      - Form I-140, Immigrant Petition for Alien Worker
      - Form ETA-750, Application for Alien Employment Certification
      - Form OF-230, Application for Immigrant Visa and Alien Registration

How to Claim the Closer Connection Exception

- - You must file Form 8840, Closer Connection Exception Statement for Aliens, to claim the Closer Connection Exception.
  - If you are filing a U.S. federal income tax return please attach Form 8840 to the income tax return.
  - If you do not have to file a U.S. federal income tax return, send Form 8840 to the Internal Revenue Service Center (indicated in the instructions attached to Form 8840) by the due date for filing the income tax return.

Late Filing Penalties May Be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.

**Need Help Finding an Experienced Offshore Tax Attorney?**

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.

Contact our firm today for assistance.

Closer Connection Exception to the Substantial Presence Test: 2024