Not everyone who meets the IRS Substantial Presence Test will qualify as a U.S. Taxpayer.
For many individuals who are not born in the United States but relocated to the United States to work for a significant period of time each year, they are usually in for a big surprise once they learn that they are required to file taxes just as if they were a US person.
In other words, for individuals who meet the Substantial Presence Test their required to file a tax return just as if they were a US citizen or legal permanent resident – which then permits the United States to tax them on their worldwide Income.
Luckily, the United States does provide some exceptions to the Substantial Presence Test:
What is the Substantial Presence Test?
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.
IRS Substantial Presence Test generally means that you were present in the United States for at least 30 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.
Exceptions to the Substantial Presence Test
The goal of the United States is not to trick individuals into getting tax as if they were US persons – rather, it is to ensure that the United States can collect tax on individuals who enjoy the benefit of residing in the United States. In order to combat against certain individuals who clearly had no intent of being substantially present in the United States from being subject to tax as if they were a US person, the following are some common exceptions that may assist you:
Commuters from Canada and Mexico
The general rule is that if a person regularly commutes from either Canada or Mexico to the United States than during the day of commuting, it is not counted toward the days needed to meet the substantial presence test. There are certain restrictions, including the requirement that the individual commute to a US place of employment or self-employment on more than 75% of the work that is included in the working period.
For example, a person is traveling between two different locations outside of the United States but the airplane stops in the United States for a layover for less than 24 hours than the layover does not count toward the substantial presence. It is very important to keep in mind that if business is conducted (even at the airport) and the stopover will count toward the center present test.
*This exception comes into play when a person may have came to the United States for significant portion of time earlier in the year and is on the cusp of meeting the substantial presence test and still has some traveling to do in which he or she will be spending even layovers in the United States.
It is important to note that to meet the medical emergency exception the person must have intended on leaving the United States but only due to a medical emergency was unable to. This is not the same as coming to the United States for the purpose of medical care and then being forced to remain in the United States (in the latter scenario it will be much more difficult to meet the substantial presence test exception.)
Most of the time, Diplomats and their immediate family members are not subject to the substantial presence test.
Certain Visa Holders
Generally, teachers, trainees and students are not subject to the substantial presence test until they made other requirements such as spending significant amounts of time in the United States following the expiration of the visa or during graduate studies.
Charitable Sports Events
If a professional athlete has come to the United States for the purpose of participating in a charitable sport event, then those days are not applied toward meeting the substantial presence test.
These are just some of the more common exceptions to the substantial presence. Expats in general have certain requirements they must be aware of when traveling.
The following is a summary of general expat tax law.
Expat Tax Lawyers
Ever since the international tax law, FATCA (Foreign Account Tax Compliance Act) was introduced, foreign tax law compliance has become much more complicated. Under the new stricter compliance requirements, Expats are finding themselves under the watchful eye of the IRS and Department of Treasury. The failure to comply may result in having their entire foreign account balance forfeited, as well as the loss of their freedom to travel.
Retaining an Expat Tax Lawyer to resolve IRS Tax issues can help get you, your family, and your business back into IRS Tax compliance.
Prior to the introduction of FATCA, international tax law compliance was relatively easy, if non-existent. U.S. citizens could simply pack up and move overseas without much hassle and/or Legal Permanent Residents could just relinquish their green cards and return home. Moreover, the “Expatriation Tax” was much simpler to circumvent – with a much less strict definition of covered expatriates.
Then came 9/11 followed by stricter international regime and subsequently, FATCA. Even beyond FATCA , there is a new international tax law brewing which is called GATCA/CRS (Global Account Tax Compliance Act/Common Reporting Standard). GATCA/CRS is commonly referred to as the Global FATCA.
Worse yet, the U.S. is threatening individuals with more than $50,000 in tax debt of having their passport revoked – all of which has made the transition to Expat a lot more murky and dangerous.
EXPATS & FATCA
When it comes to U.S. Expats, the biggest change in international law is in the form of FATCA (Foreign Account Tax Compliance Act). Under FATCA, U.S. Taxpayers (Expats, US citizens, Legal Permanent Residents, and Foreign Nationals subject to US tax) are required to annually report their overseas and foreign accounts to the Internal Revenue Service and Department of Treasury; the failure to do so can be very costly, with FBAR penalties alone reaching 100% of the account value.
Why are U.S. Expats Required to File Tax Returns
The requirement to file U.S. tax returns (unless a person is otherwise exempted or excluded) is a requirement that comes along with being a US citizen and/or legal permanent resident. Under U.S. tax law, the United States taxes U.S. taxpayers on their worldwide income. That means that even if you are a U.S. Expat and earn the money outside of the United States (Whether you are a resident of the U.S or not), you are required to file a tax return, report the income and usually pay tax on the money (Unless the Foreign Tax Credit or Foreign Earned Income Exclusion applies).
Why are U.S. Expats Required to Report Foreign Accounts?
While people who oppose FATCA have many different reasons as to why FATCA is unfair, for the most part the law itself is not unfair – the real problem is how foreign financial institutions and other foreign banks are interpreting and applying the law.
One of the main reasons why US expats are required to disclose their foreign accounts is so that the United States can track the value of their foreign accounts for estate planning/estate tax and gift tax purposes. For example, in the United States the gift and estate tax exemption is $5.45 million per person. For purposes of this example, let’s assume that the person is single. With this exemption it means that if the person was to die in 2016 (absent complicated gift tax and claw-back rules) and his estate was worth $5 million, then there would be no estate taxes due.
On the other hand, let’s is the same facts only the person is worth $10 million. Due to the value of the person’s estate, his estate may have to pay estate tax at the rate of 40% for every dollar over $5.45 Million. In other words, the estate would have to pay roughly $1.85 million in estate tax. Now, if the person who is a US citizen but is also a US expat lives overseas and has their money in a foreign account with a foreign beneficiary that the IRS cannot trace or locate, the IRS cannot collect that nearly $2 million in tax money. As a result, by requiring all US taxpayers to report and disclose their foreign offshore accounts, the IRS can track each person’s value. (There is a specific rule for long-term U.S. Residents who relocate overseas and then gift money back to the United States)
FATCA is being interpreted unfairly and impacting U.S. Expats
Although the purpose behind FATCA may be legitimate, the law itself is being interpreted poorly by foreign countries — which is having a severely negative impact on US Expats. Many foreign countries do not want to deal with the headache of reporting US taxpayer accounts to the United States, and instead are either refusing to open new accounts or actually closing or downgrading US expat accounts.
**If you are a US expat residing overseas and are unable to open a bank account this can be a very difficult, if not impossible situation and you may want to seek the advice of counsel.
***While this is not the intent of FATCA, it is the direct result of poor planning on behalf of the United States.
What if the U.S. Expat Does not Disclose the Information
If a U.S. Expat fails to disclose their foreign account information to the United States, then they may suffer significant fines and penalties if not forfeiture of their money. The penalties involved with the failure to disclose international and foreign money is archaic and completely unfair to the taxpayer.
What forms are U.S. Expats required to file?
The number of forms that are required to be filed will depend on the amount of offshore assets, and whether the taxpayer is married filing jointly or not. Here’s a brief list of some of the more common forms that are required to be filed by U.S. Taxpayers, including U.S. Expats:
- FBAR (FInCEN 114): This form is required to be filed with the Department of Treasury if the total aggregate total of your overseas accounts exceed $10,000 in them or more on any given day (if you have 11 accounts with $1000 each of them you still have to report all the accounts). This form is not filed with your tax return but rather is filed directly with the Department of Treasury and is now required to be filed online. This form cannot be filed late otherwise it is considered a silent disclosure and could lead to potential fines and even criminal penalties.
- IRS Form 8938: This form is filed with your tax returns, and the thresholds for filing them depends on whether you are single or married, and if you reside in the U.S. or overseas. The minimum threshold is that if you have $50,000 or more in foreign accounts on the last day of the year or $75,000 in the account at any time during the year then you are required to file this form.
- Schedule B: Schedule B is generally filed when you earn a certain amount of dividends or interest income during the year (U.S. or Foreign Interest/Dividend income). It is important to note that if you have any interest in a foreign account then you are still required to file the form even if you did not earn any interest or dividends another job.
***If you filed a Schedule B but did not disclose your foreign accounts in accordance with question 7, you should speak with an international tax attorney to discuss the implications.
- IRS Form 3520: this form is required to be filed depending on whether you have an overseas trust or receive gifts that meet or exceed the threshold amount.
What can the IRS do to a U.S. Expat who lives in a Foreign Country?
If you are a U.S. Expat who lives in a foreign country and the IRS finds that you were required to, but did not file you U.S. tax returns, they will seek to put a lien or levy – or worse – against both your United States and foreign bank accounts and property. The reason they will be able to do this is because many countries have entered into intergovernmental agreements (IGAs) with the United States, which are reciprocal arrangements by the countries to report and take any means necessary in order to ensure all taxes are paid.
Further, in countries that do not have an intergovernmental agreement (IGA) with the IRS, if your bank account in this country is either a US bank, a bank that has US branches, or a foreign bank that uses a third-party US-bank such as HSBC to transfer funds to different countries, U.S. Expats will most likely get caught in the web as well.
But I haven’t filed Tax Returns of Filed FBARs in many years?
If you have not filed tax returns or filed FBARs, the best strategy is usually to enter the OVDP (Offshore Voluntary Disclosure Program) or IRS Streamlined Program.
The two programs are summarized below:
OVDP vs. IRS Streamlined Program
If you or your business has unreported or undisclosed foreign accounts, offshore assets, or foreign income then you may be considering whether you should enter the Offshore Voluntary Disclosure Program (OVDP) or the modified streamlined program.
Both programs provide peace of mind to the taxpayer – but it will depend on the facts and circumstances of each taxpayer’s situation, to determine which program(s) they qualify for. It is important to note that the failure to properly submit to the correct program can have serious consequences to the taxpayer.
Why Comply with IRS Foreign Disclosure Laws?
Because if you fail to do so, the IRS has the authority to penalize you upwards of 100% of the value of your offshore assets and accounts as well as prosecute you for criminal tax fraud and tax evasion if it is found that you acted willfully in failing to report your assets and foreign income.
The reason why international tax law compliance has taken center stage is because under the new FATCA (Foreign Account Tax Compliance Act) laws, foreign countries are actively reporting the bank and financial accounts of US citizens and US legal permanent residents. If a foreign country is interested in working with the United States, the foreign country will enter into an “ Intergovernmental Agreement” (IGA). These agreements are reciprocity agreements, which means not only will the foreign country report the information to the IRS, but the IRS will also reciprocate by providing the same information to foreign country tax authorities.
Why Enter either OVDP or the Modified Streamlined Program?
Individuals and businesses who are looking for a way to avoid the very steep penalties may seek to voluntary disclose, pay a penalty (unless abated), and avoid criminal prosecution.
There are the only two approved programs by the Internal Revenue Service that can bring a taxpayer into compliance. Instead of entering the programs, taxpayer may qualify to directly report under the reasonable cause exception, in which the taxpayer directly submits the forms with a statement explaining why they were not properly filed.
*Please note, the IRS is not known to be sympathetic and if the IRS does not believe you and audits you anyway then you are disqualified from entering either the OVDP or streamlined program AND the IRS is have more of your overseas/foreign financial information you would like probably like.
Moreover, if the taxpayer improperly submits the forms to the IRS it can be considered “silent disclosure” or “quiet disclosure,” in which if detected by the IRS, the IRS will penalize you heavily as well as probably initiate criminal proceedings against you. In this scenario, not only with the IRS seek to take all of your money and assets through the implementation of penalties and levies, but chances are you will also be spending the next 2 to 20 years in prison for tax evasion or tax fraud.
What is the Difference between OVDP and the Streamlined Program?
Before making a decision regarding voluntary disclosure, it is important to understand the difference between the two main programs.
OVDP (Offshore Voluntary Disclosure Program Requirements)
OVDP stands for the Offshore Voluntary Disclosure Program, which came into effect in 2009 and was modified again in 2011, 2012 and 2014.
Before the implementation of the modified streamlined program (which is strictly for individuals who were non-willful in their failure to report their overseas assets and income) the penalty structure was generally (and continues to be for willful participants) 27.5% of the highest years annual aggregate total and 50% if any of your money was held in one of the identified “bad banks.”
In other words, if you have foreign accounts that were unreported to the IRS and Department of Treasury, then to determine your penalty structure you would need to total up all of your unreported overseas and accounts for each year, for the last eight years, and then take the highest year’s highest balance and multiply it by 27.5% to arrive at the penalty amount due. (A complete breakdown of OVDP requirements can be found on our OVDP Page, by Clicking Here)
OVDP is Unfair for Non-Willful Taxpayers
Before the implementation of the modified streamlined program, it was difficult for individuals who were non-willful (no specific definition, but generally without intent to deceive or defraud) to become compliant. Why? Because if you are non-willful, you still had to go through the filing procedures as if you were willful, and then opt out of the penalty structure and open yourself up for audit.
Not such a big deal, except for the fact that you also had to pay 20% penalty on the outstanding taxes that you owed along with a 27.5% penalty on the highest year’s annual aggregate (unless you successfully “opted out” from the penalty structure – which came with a whole other set of headaches). As you can imagine, for individuals who simply inherited some money overseas, had no international dealings, and had no idea that they were required to report foreign passive income (Interest income) in a country that does not tax its own citizens on passive income earnings — providing this information to the IRS was a huge burden.
What is the Modified Streamlined Program?
In order to avoid “non-willful” applicants from having to go through the entire OVDP process before opting out, the IRS and Department of the Treasury modified a small program in existence, called the streamlined program, which was very limited. The IRS expanded the program to basically allow anyone who was non-willful to enter the program.
The program reduced the amount of documentation that applicants were required to file to only three years of amended tax returns and six years of FBAR (Foreign Account Reporting Statements). In addition, there was no penalty on the tax amount that was due, no penalty on the value of foreign real estate that was not previously disclosed, and the 27.5% penalty was reduced all the way down to 5%, or completely waived if the foreign residence requirements were met.
Penalty Waiver: there is a small facet of the modified streamlined program called the Modified Foreign Offshore Program. If a person qualifies for the modified stream of program (which means they acted non willfully) and they can prove they lived overseas in any number of different countries for a total of 330 days out of the tax year in any year within the last three years, then they may qualify to have the penalty waived.
The Streamlined Programs sounds great, right? Well it is, unless you are attempting to wrongfully evade the 27.5% penalty by entering the program when you knew you were willful.
What if you are caught trying to sneak into the Streamlined Program?
I cannot stress to you enough to not enter the streamlined program if you do not qualify; in other words, suck it up and pay the penalty. Why? Because if you knowingly enter the streamlined program and it is found that you acted willfully in your failure to disclose and report your overseas and foreign assets and income you will most likely be prosecuted by the IRS.
The IRS made this fact known in a recent public relations statement in March 2015. Essentially, from the IRS’ perspective if you wrongfully enter this program in order to avoid paying the full penalty amount what you have done is stolen 27.5% or 50% of the penalty amount due to the IRS – and this does not make the IRS very happy.
Even worse is that not only are you subject to criminal prosecution – but now you’ve already disclosed all the foreign financial information and thus you’re in a pretty difficult position to defend yourself. The IRS has let it be known that they will enforce criminal tax prosecution laws in these types of situations.
Why is the Modified Streamlined program in Jeopardy?
Just like in everything in life, a few bad apples spoil the whole bunch. The IRS has gotten wind that several individuals who were willful in their failure to report undisclosed foreign tax and bank information are trying to sneak into the modified streamlined program and thus reduce their penalty to 5%. As you can imagine, this upset the IRS who created this modified program for the sole purpose of assisting taxpayers who otherwise would be overburdened and having to enter the OVDP and opt out of the penalty structure.
There is No Reason to be Scared of the OVDP or the Streamlined Programs
The goal of this article is not to scare you. Rather, it is to warn you to just be cautious if you are entering into these programs. Way too many inexperienced and unscrupulous attorneys, CPAs and enrolled agents see these programs as a way to scare individuals.
If You are going to enter a Foreign Disclosure Program, use an Attorney
While CPAs and enrolled agents (who are not also attorneys) may charge less than an attorney is important to note that you do not have an attorney client privilege with CPAs and enrolled agents. What that means, is that if it turns out you wrongfully entered the streamlined program and the IRS wants to speak with your representative, unless your representative is an attorney, there is no privilege between a CPA and Taxpayer when a Criminal Matter is at issue.