201601.12
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Tax Lawyers for Foreign Expats | Substantial Presence Test Exemption – International Tax

Golding & Golding - U.S. and International Tax Lawyers

Golding & Golding – U.S. and International Tax Lawyers

Substantial Presence Test for Foreigners: An expatriate or “Expat” is a person who travels and resides in a foreign country. It is not uncommon for foreign expatriates to come to the United States for work, employment or relocation.

One of the most difficult concepts for the foreign person to understand is how the US tax system works with respect to their earnings. In this article, we will explain how the tax system impacts a foreigner as well as the tax liability and what he or she can do to try to limit US tax liability.

Worldwide Income Tax

The United States is unlike several other countries in that the United States taxes individuals on their worldwide income. That means if you qualify as either a US Citizen, Legal Permanent Resident, or Foreign National who meets the Substantial Presence Test, then the IRS will tax you on your worldwide income. This can become a problem when a person works in the United States part time and/or earn significant income in other countries in which the foreign ex-pat must also pay tax in those other countries as well.

In most countries, a person is only taxed on the income they earn in a particular country. For example, if Michelle is originally from Brazil and moves to Singapore to work, then Singapore would generally have the right to tax Michelle on the earnings from Singapore. Brazil would not also tax Michelle on the earnings in Singapore because she is not residing in Brazil and not earning any income from Brazil – even though she is still a Brazilian citizen.

U.S. Tax – Substantial Presence Test

In the United States, if a person is a US Citizen or Legal Permanent Resident they are taxed on their worldwide income. There is also a third category, called “Substantial Presence Test “and it is a trap for the unwary. By meeting the Substantial Presence Test a foreigner may become inadvertently liable in the United States for their worldwide tax liability.

Example: Scott is a foreign national who travels  to the United States six or seven months out of the year to perform consulting services. As long as Scott is here for at least 30 days in the current year and 183-days over the last three years (using the 1 to 1, 1 to 3, and 1 to 6 test ratios) then he will become substantially present in the United States (unless he can show otherwise).

In the current year for every day Scott is in the United States, it counts as one day toward the 183-days. For every day Scott was in the United States in the preceding year, each day counts toward a third of a day the 183-day requirement, so that a person would have to be here for three days in the prior year for it to count as one full the 183-day/3 year requirement. Going back two years, the ratio is 1 to 6.

*Generally, if a person is here for around four months out of every year, they will qualify for the substantial presence test

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:

Exempt Individual

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 individua lunder an “A” or “G” visa, other than individuals holding “A-3” or “G-5” class visas.
  • teacher or trainee temporarily present in the U.S. under a “J” or “Q” visa, who substantially complies with the requirements of the visa.
  • student temporarily present in the U.S. under an “F,” “J,” “M,” or “Q” visa, who substantially complies with the requirements of the visa.
  • 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;

  1. The closer connection exception available to all aliens. Please refer to Conditions for a Closer Connection to a Foreign Country.
  2. 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.

Form 8843

If you meet the exception, you must file IRS Form 8843 to avoid taxes and penalties. The IRS provides the following instructions/summary regarding the use of this form:

Exempt Individuals For purposes of the substantial presence test, an exempt individual includes anyone in the following categories.

  • A teacher or trainee (defined on this page).
  • A student (defined on the next page).
  • A professional athlete temporarily present in the United States to compete in a charitable sports event.

The term exempt individual also includes an individual temporarily present in the United States as a foreign government-related individual under an “A” or “G” visa. If you are present under an “A” or “G” visa, you are not required to file Form 8843.

Specific Instructions Part I —General Information

If you are attaching Form 8843 to Form 1040NR or Form 1040NR-EZ, you are not required to complete lines 1a through 4a of Form 8843 if you provide the requested information on the corresponding lines of Form 1040NR or 1040NR-EZ. In this case, enter “Information provided on Form 1040NR” or “Information provided on Form 1040NR-EZ” on line 1a of Form 8843. Line 1b.

Enter your current nonimmigrant status, such as that shown on your current Immigration Form I-94, Arrival-Departure Record. If your status has changed while in the United States, enter the date of change.

Part II—Teachers and Trainees

A teacher or trainee is an individual who is temporarily present in the United States under a “J” or “Q” visa (other than as a student) and who substantially complies with the requirements of the visa. If you were a teacher or trainee under a “J” or “Q” visa, you are considered to have substantially complied with the visa requirements if you have not engaged in activities that are prohibited by U.S. immigration laws that could result in the loss of your “J” or “Q” visa status.

Even if you meet these requirements, you cannot exclude days of presence in 2015 as a teacher or trainee if you were exempt as a teacher, trainee, or student for any part of 2 of the 6 prior calendar years. But see the Exception below. If you qualify to exclude days of presence as a teacher or trainee, complete Parts I and II of Form 8843. If you have a “Q” visa, complete Part I and only lines 6 through 8 of Part II.

On line 6, enter the name, address, and telephone number of the director of the cultural exchange program in which you participated. Exception. If you were exempt as a teacher, trainee, or student for any part of 2 of the 6 prior calendar years, you can exclude days of presence in 2015 as a teacher or trainee only if all four of the following apply.

  1. You were exempt as a teacher, trainee, or student for any part of 3 (or fewer) of the 6 prior calendar years.
  2. A foreign employer paid all your compensation during 2015.
  3. You were present in the United States as a teacher or trainee in any of the 6 prior years.
  4. A foreign employer paid all of your compensation during each of those prior 6 years you were present in the United States as a teacher or trainee. For more details, see Pub. 519, U.S. Tax Guide for Aliens.

If you meet this exception, you must attach information to verify that a foreign employer paid all the compensation you received in 2015 and all prior years that you were present in the United States as a teacher or trainee.

Part III—Students

A student is an individual who is temporarily present in the United States under an “F,” “J,” “M,” or “Q” visa and who substantially complies with the requirements of the visa. If you were a student under an “F,” “J,” “M,” or “Q” visa, you are considered to have substantially complied with the visa requirements if you have not engaged in activities that are prohibited by U.S. immigration laws and could result in the loss of your visa status.

Even if you meet these requirements, you cannot exclude days of presence in 2015 as a student if you were exempt as a teacher, trainee, or student for any part of more than 5 calendar years unless you establish that you do not intend to reside permanently in the United States. The facts and circumstances to be considered in determining if you have established that you do not intend to reside permanently in the United States include, but are not limited to:

  1. Whether you have maintained a closer connection to a foreign country than to the United States (for details, see Pub. 519) and
  2. Whether you have taken affirmative steps to change your status from nonimmigrant to lawful permanent resident. If you qualify to exclude days of presence as a student, complete Parts I and III of Form 8843. If you have a “Q” visa, complete Part I and only lines 10 through 14 of Part III. On line 10, enter the name, address, and telephone number of the director of the cultural exchange program in which you participated.

Part IV—Professional Athletes

A professional athlete is an individual who is temporarily present in the United States to compete in a charitable sports event. For details on charitable sports events, see Pub. 519. If you qualify to exclude days of presence as a professional athlete, complete Parts I and IV of Form 8843.

Part V—Individuals With a Medical Condition or Medical Problem

For purposes of the substantial presence test, do not count the days you intended to leave the United States but could not do so because of a medical condition or medical problem that arose while you were in the United States. Whether you intended to leave the United States on a particular day is determined based on all the facts and circumstances. For more details, see Pub. 519. If you qualify to exclude days of presence because of a medical condition or medical problem, complete Part I and lines 17a through 17c of Part V. Have your physician or other medical official complete line 18. Paperwork Reduction Act Notice. We ask for the information on this form to carry out the Internal Revenue laws of the United States. Section 7701(b) and its regulations require that you give us the information.

We need it to determine if you can exclude days of presence in the United States for purposes of the substantial presence test. You are not required to provide the information requested on a form that is subject to the Paperwork Reduction Act unless the form displays a valid OMB control number. Books or records relating to a form or its instructions must be retained as long as their contents may become material in the administration of any Internal Revenue law. Generally, tax returns and return information are confidential, as required by section 6103. The average time and expenses required to complete and file this form will vary depending on individual circumstances. For the estimated averages, see the instructions for your income tax return.