Substantial Presence Test vs. 330 Day Rule (SFOP) – Streamlined Foreign Offshore
- 1 A Few Key Points
- 2 Streamlined Foreign Offshore Procedures (SFOP)
- 3 Benefits of SFOP
- 4 Qualifying as a Foreign Resident
- 5 Understanding Substantial Presence Test. (SPT)
- 6 Who Qualifies under the Substantial Presence Test?
- 7 Summary of Substantial Presence Test
- 8 Tax Liability – Substantial Presence Test
- 9 Substantial Presence Test – Exception
- 10 330-Day Foreign Resident Rule
- 11 Applying the 330-day Non-Resident Rule
- 12 What if the Years were Staggered?
- 13 BOTH Spouses Must Meet the requirements
- 14 Golding & Golding, A PLC
This post is designed to be the first in a two-part series Re: Streamlined Foreign Offshore Procedures involving some of the key nuances involved in meeting the requirements as a foreign resident vs. non-resident.
Before discussing the ambiguity of the current vs. former U.S. Citizen description in the 14653 (IRS Streamlined Foreign), it is important to understand the two different tests being used to evaluate non-residence: 330-Day Non-Resident vs. Substantial Presence Test (SPT).
A Few Key Points
The requirements for showing you are a Non-Resident under the Substantial Presence Test are different than showing that you are a U.S. Person who meets the “Non-Resident” test for the Streamlined Foreign Offshore Procedures (SFOP) – aka lived abroad for at least 330-days in any one tax year.
The 330-day Foreign Earned Income Exclusion (FEIE) Physical Presence Test is not the same as the 330-day U.S. Non-Resident Rule under Streamlined Filing Compliance Procedures. And, just because you meet the FEIE Physical Presence Test does not mean you will necessarily meet the U.S. Non-Resident Rule Under Streamlined Filing Compliance Procedures.
Streamlined Foreign Offshore Procedures (SFOP)
We write about SFOP often, because it is a great program. In fact, out of all the different options an individual may have when they have not properly reported or disclosed their offshore accounts, offshore investments, offshore income, foreign retirement, and/or other non-US-based assets – the Streamlined Foreign Offshore Procedures may be the best possible option.
Why? First, it is one of the approved “Streamlined Programs,” which means there are much more lenient requirements in terms of the reporting the tax responsibilities for the applicant than there are under traditional OVDP. Moreover, the penalties are waived, and the submission process is relatively less stressful than a full blown OVDP — or even Streamlined Domestic.
Benefits of SFOP
Some of the benefits of SFOP are the following:
3 Years of Tax Returns
Unlike traditional OVDP in which a person must amend or file original returns for eight years (8), under the Streamlined Foreign Offshore Procedures a person is only required to amend or file original returns for three (3) years.
**Under Streamlined Domestic Offshore Procedures, a person must have filed timely (including extensions) tax returns to qualify for the program, but under streamlined foreign that is not required. In other words, a person may file original returns using the Streamlined Foreign Offshore Procedures.
6 Years of FBARs
Under the Streamlined Foreign Offshore Procedures, a person must only file six (6) years FBARs instead of eight (8) years. The reason for requiring six years is because — short of the IRS proving fraud,” the IRS is limited to a six year statue limitations to go back and audit a person for Tax and FBAR related matters.
All Penalties Waived
This is the best part of the program – there is no penalty. That means there is no penalty on the outstanding balance and there is no penalty on the taxes that are due each year. Under the Streamlined Domestic Offshore Procedures the penalties are 5%, and under traditional OVDP, the penalties can reach as high as 50% – along with an annual penalty for each year there is unreported tax.
Qualifying as a Foreign Resident
Aside from the requirement that a person prove he or she is non-willful — which is entirely different discussion for another day — (Click Here for a Comprehensive article on Willful vs. Non-Willful) – a person must prove they resided outside of the United States in order to qualify. Depending on whether a person is considered to be a US resident or nonresident will make the difference between which test they must meet, in which elements they must prove.
The first test as for nonresidents and that is called the Substantial Presence Test. (SPT)
Understanding Substantial Presence Test. (SPT)
The United States is one of the only countries in the world the practices Citizen-Based Taxation (CBT). In other words, the United States taxes US persons on their worldwide income.
When a person is a U.S. Citizen, Legal Permanent Resident (“Green Card Holder”), or long-term Legal Permanent Resident who did not properly relinquish their Green Card, a person will be taxed on all of the income they earn worldwide. It does not matter if they earned the income while living in the United States or abroad. It also does not matter whether the income is sourced in the United States or outside the United States – it must be reported on the US tax return.
Who Qualifies under the Substantial Presence Test?
The Substantial Presence Test takes the matter one step further, in order to tax individuals who are neither a U.S. Citizen, Legal Permanent Resident (“Green Card Holder”), or long-term Legal Permanent Resident who did not properly relinquish their Green Card. Even if a person does not meet one of the aforementioned U.S. Citizen/Resident categories, but meets a certain “Resident Test “- he or she will have to pay tax on their worldwide income in the United States just as it they were a U.S. Person
Usually, it will involve individuals who are in the United States on a work visa. For example, David was transferred to the United States by his company on an L-1 visa. As a result, even though David may have no intention of trying to obtain U.S. Legal Permanent Residency, if he meets the substantial presence test that you will have to pay tax on his worldwide income.
For David, the tax results will be catastrophic. Why? Because in David’s home country of Hong Kong, the country does not tax individuals on their passive income. David has amassed a significant nest egg abroad, and is earning upwards of 8% on $2 million he has saved in his bank account. While that money cannot be taxed by Hong Kong, the United States can tax his “worldwide income” which would include the hundred and $160,000 a year he is earning in interest income.
**Since Hong Kong does not tax this category of income, David would have no tax credits to apply to reduce his tax liability – as opposed to Australia for example where individuals are tax similar to the United States.
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.
Tax Liability – Substantial Presence Test
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.
Substantial Presence Test – Exception
There is an exception to this filing rule, depending on the purpose of the foreigner being in the United States and what role/job the person is doing in the United States.
The IRS provides the following involving the substantial presence exception:
Do not count days for which you are an exempt individual. The term “exempt individual” does not refer to someone exempt from U.S. tax, but to anyone in the following categories:
- An individual temporarily present in the U.S. as a foreign government-related individual under an “A” or “G” visa, other than individuals holding “A-3” or “G-5” class visas.
- A teacher or trainee temporarily present in the U.S. under a “J” or “Q” visa, who substantially complies with the requirements of the visa.
- A student temporarily present in the U.S. under an “F,” “J,” “M,” or “Q” visa, who substantially complies with the requirements of the visa.
- A professional athlete temporarily in the U.S. to compete in a charitable sports event.
If you exclude days of presence in the U.S. for purposes of the substantial presence test because you were an exempt individual or were unable to leave the U.S. because of a medical condition or medical problem, you must include Form 8843, Statement for Exempt Individuals and Individuals With a Medical Condition, with your income tax return. If you do not have to file an income tax return, send Form 8843 to the address indicated in the instructions for Form 8843 by the due date for filing an income tax return.
If you do not timely file Form 8843, you cannot exclude the days you were present in the U.S. as an exempt individual or because of a medical condition that arose while you were in the U.S. This does not apply if you can show, by clear and convincing evidence that you took reasonable actions to become aware of the filing requirements and significant steps to comply with those requirements.
Closer Connection Exception to the Substantial Presence Test
Even if you passed the substantial presence test you can still be treated as a nonresident alien if you qualify for one of the following exceptions;
- The closer connection exception available to all aliens. Please refer to Conditions for a Closer Connection to a Foreign Country.
- The closer connection exception available only to students. Please refer to The Closer Connection Exception to the Substantial Presence Test for Foreign Students and Sample Letter.
330-Day Foreign Resident Rule
Unlike the Substantial Presence Test, the Streamlined Foreign Offshore Procedures “Non-Resident Test” for U.S. Persons is much different – and much more stringent. Why? Because the United States government does provide as much deference to individuals who are considered citizens or permanent residence and therefore “should have known the rules.”
Under these circumstances, the person must meet a very strict 330-day rule.
Applying the 330-day Non-Resident Rule
It is almost as simple as it sounds – a person must have resided outside the United States (in either one country or multiple countries) for at least 330 days in any one of the three years being included in the tax submission, and without having a U.S. Abode.
Example: Scott is originally from California but was transferred to Singapore for five (5) years by his company to run research operations for his company. He brought his family with him, and therefore did not come back to the United States at all during the five-year time period. This would be an example of someone who lived outside the United States for at least 330 days.
What if the Years were Staggered?
Without getting too complicated, the 330-Day rule for the Streamlined Foreign Offshore Procedures is not the same as the 330-Day rule for the Foreign Earned Income Exclusion.
To qualify under the streamlined foreign, a person must have been outside of the United States for at least 330 days in any one or more of the most recent three years for which the tax return due date has already passed – and there must not be any abode in the United States.
In other words, it includes a full tax year. So for the example above, Scott would have no issue. On the other hand, let’s say Peter lived outside of the United States for 330 days, but the years were staggered so that he was outside United States from May 2014 to April 2015. Even though he was outside the United States the 330 days it was not in one of the most recent three taxes – rather, it was staggered over to tax years and generally will not qualify.
**With that said, each individual has different circumstances and the IRS has been known to bend or lean in certain situations and so it never hurts to contact the IRS and ask them (anonymously, through your counsel) whether the IRS may allow for a variance.
BOTH Spouses Must Meet the requirements
Under either circumstance, both spouses must meet the requirement to qualify for streamlined foreign. Therefore, using the 330-day rule, if one spouse lived outside the United States for 340 days, and the other spouse only lived outside for 320 days, they would not meet the test as to the spouse who lived outside the United States for only 320 days.
Rather, the spouse who did not meet the residence requirement would have to submit under a different program, and if she used the Streamlined Domestic Offshore Procedures, she would have to submit under the streamlined domestic offshore procedures and could be subject 5% penalty.
**Important to note, is that only the person who has interest in the money is penalized. Therefore, if all of the money belongs to the one spouse who lives outside of the United States and meets the foreign resident requirement than that spouse would have no penalty on that money.
Example: Dean lived outside the United States for 340 days. He earned significant income abroad, and has a foreign account with $3 million. His spouse is not identified on the account and none of the money belongs to her (also, they do not live in a community property state). Therefore, even though his spouse does not meet the foreign resident requirement, the penalty may still be waived as to Peter.
Golding & Golding, A PLC
We have successfully represented clients in more than 1,000 streamlined and voluntary disclosure submissions nationwide and in over 70-different countries.
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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. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.
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