- 1 Form 8840 (An Exception to an Exception)
- 2 U.S. Tax and Reporting General Rule
- 3 What is Substantial Presence?
- 4 What does it Mean if you “Meet Substantial Presence”
- 5 How Does the Substantial Presence Test Work?
- 6 What is a Closer Connection to Another Country?
- 7 How do You Show a “Closer Connection?”
- 8 If you Do Not Meet Closer Connection & are out of Compliance…
- 9 What Should You Do?
- 10 4 Types of IRS Voluntary Disclosure Programs
Form 8840 (2019) – IRS Closer Connection & Substantial Presence Help
Form 8840 (An Exception to an Exception)
For some non-U.S. Persons (Aliens), who are neither U.S. Citizens nor Legal Permanent Residents — but meet the IRS Substantial Presence Test — they suddenly become subject to U.S. Tax and Reporting in the U.S.
Thankfully, the IRS developed an exception to the rule, which a taxpayer may claim by submitting a Form 8840.
Form 8840 is used to avoid the U.S. worldwide tax and reporting rules if you can show a closer connection to another country.
U.S. Tax and Reporting General Rule
Only U.S. Persons (Citizens and Legal Permanent Residents) are subject to U.S. Tax on worldwide income.
U.S. Tax and Reporting Exception to the General Rule
Non-U.S. Persons who meet the Substantial Presence Test are also subject to U.S. Tax and Reporting (FBAR, FATCA, PFIC, etc.) on their worldwide income, accounts, assets, and investments.
U.S. Tax and Reporting Exception to the Exception
Even if you meet the Substantial Presence Test, you may be excepted from U.S. Tax, if you can show a “Closer Connection.”
What is Substantial Presence?
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 finally 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:
What does it Mean if you “Meet Substantial Presence”
Once a person meets the substantial presence test, they are required to report their worldwide income in the United States on a 1040 instead of at 1040 NR. Depending on any tax treaties the United States has with any particular country, the foreigner may find himself or herself under heavy tax scrutiny by the United States.
How Does the Substantial Presence Test Work?
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 a Closer Connection to Another Country?
As provided by the IRS:
Even though you would otherwise meet the substantial presence test, you will not be treated as a U.S. resident for 2018 if:
You were present in the United States for fewer than 183 days during 2018;
You establish that during 2018, you had a tax home in a foreign country; and
You establish that during 2018, you had a closer connection to one foreign country in which you had a tax home than to the U.S.
How do You Show a “Closer Connection?”
As provided by the IRS:
You can demonstrate that you have a closer connection to two foreign countries (but not more than two) if all five of the following apply:
1. You maintained a tax home as of January 1, 2018, in one foreign country
2. You changed your tax home during 2018 to a second foreign country.
3. You continued to maintain your tax home in the second foreign country for the rest of 2018.
4. 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.
5. You are subject to tax as a resident under the tax laws of either foreign country for all of 2018 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.
If you Do Not Meet Closer Connection & are out of Compliance…
We can help!
If you are out of offshore compliance, the penalties can be severe. Therefore, you may consider entering the IRS offshore voluntary disclosure/tax amnesty, before it is too late.
What Should You Do?
Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.
4 Types of IRS Voluntary Disclosure Programs
There are typically four types of IRS Voluntary Disclosure programs, and they include:
- Traditional (IRM) IRS Voluntary Disclosure Program
- Streamlined Domestic Offshore Procedures (SDOP)
- Streamlined Foreign Offshore Procedures (SFOP)
- Reasonable Cause (RC)
Contact Us Today; Let us Help You.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)
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