For many individuals who reside in the United States on a work or investment visa such as an H-1B, L1, EB-5 or E-2, they are usually in for a sudden surprise when they learn that as long as they met the substantial presence test in the United States, they will be subject to US tax just as if they were US citizen or legal permanent resident.
Many foreign employers are not aware of this requirement and do not even tell the employee for whom they transferred to the United States.
Work Visa – Substantial Presence Test
The United States likes to tax individuals who reside within their borders. For individuals who are U.S. Citizens or Legal Permanent Residents, the idea that they are being taxed on their worldwide income is not a big surprise. Why? Because as either a U.S. Citizen or Legal Permanent Residents, the majority of individuals (absent accidental Americans and ex-pats) generally intend on living in the United States full-time. In other words, they accept that they must succumb to US tax laws — and the most important US tax law for green card holders and citizens to understand is that the United States taxes them on their worldwide income (see below).
For individuals in the United States on a work visa it is a bit different. Many individuals who are in the United States on a work visa are doing so for the sole benefit of improving standard of living for themselves and their family – they have no intent to reside in the United States.
For them, learning about the substantial presence test is a rude awakening.
What is the Substantial Presence Test?
When a person first comes to the United States to live, if they earned income they are required to file a tax return. Until they become a Legal Permanent Resident or US citizen, they file a 1040-NR.
The problem for many people is that once they have lived in the United States for a certain amount of time, they become subject to regular taxation just as if they were a US citizen or Legal Permanent Resident. Not only does this mean that the United States will tax the person on the worldwide income, but they are also required to comply with all foreign account reporting requirements.
The failure to comply with foreign account reporting may result in significant fines, penalties, and even criminal investigation depending on the facts and circumstances of their case. In addition, if the person is found to be willful and their failure to report then their entire foreign accounts can be subject to a 100% penalty.
The following is a summary of the Substantial Presence Test followed by a summary of FBAR reporting requirements:
Summary of 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.
What is Worldwide Income?
The United States is one of only a handful of countries on the planet that taxes individuals on their worldwide income. What does that mean? It means that whether or not you reside in the United States or in a foreign country, you are required to report all of your US income as well as foreign source income on your US tax return.
It also does not matter if the income you earn is tax exempt in a foreign country, or whether the income you earn in a foreign country was already taxed (see below). While you may be able to obtain a credit or exemption for the taxes you paid or income you earned in a foreign country – you are still required to report the income on your US tax return.
Will my Foreign Bank Report to the IRS?
The way that many individuals that are getting the trouble is that their foreign financial institution has become aware that under FATCA (Foreign Account Tax Compliance Act) the institution must report any US account holder to the United States, and individuals who are in the United States on a work visa are considered US persons.
It may be because the foreign financial institution understands the substantial presence test, or even simpler — you may provided the foreign bank with a US address so that they can forward your bank/statement information to you in the U.S.. In either event, it is important to note that the best way to avoid major penalties is to stay in compliance.
What if I did Not Report it in Prior Years?
If you have not reported foreign income in prior years, your best option may be entering IRS Offshore Voluntary Disclosure. The following is a summary of the different IRS offshore Voluntary Disclosure Program options:
Golding & Golding: About our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe. Our attorneys have worked with thousands of clients on offshore disclosure matters, including FATCA & FBAR.
Each case is led by a Board-Certified Tax Law Specialist with 20-years experience, and the entire matter (tax and legal) is handled by our team, in-house.
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