Certain foreign nationals may avoid penalties for underpayment of estimated tax by relying on 100% of prior year tax shown on dual status return.

• Author: Fisher, Arthur L.

Sec. 6654(d) provides that an individual generally can avoid penalties for underpayment of estimated tax if he makes estimated tax payments based on 100% of the tax shown on the return of the individual for the preceding tax year. (It appears that the tax shown on this return must be greater than zero.) This rule, however, does not apply if the preceding tax year was not a tax year of 12 months or if the individual did not file a return.

Many foreign nationals who arrive in the United States will file a dual-status return or a nonresident alien return in the year of arrival. The question is: Can they base their estimated tax for the second U.S. year on the 100% tax shown on their return for the first year? The authors believe that generally they may, since they meet the 12-month test under Sec. 6654(d)(1). The prior year of a dual-status alien is a tax year of 12 months, even though the alien is not in the United States for the full 12 months. Regs. Sec. 1.871-13(a) provides that the tax year of a dual-status alien comprises two separate periods, one while a resident alien and the other while a nonresident alien.

However, this exception does not apply (other than for the first required installment) to any taxpayer who meets all three conditions under Sec. 6654(d)(1)(C). 1. The modified adjusted gross income (AGI) for the current year exceeds the amount of the adjusted gross income shown on the return of the individual for the preceding tax year by more than $40,000 ($20,000 in the case of a separate return for the current year by a married individual). 2. The AGI shown on the...