Tax issues for recent U.S. residents.

AuthorMoore, Michael L.

EXECUTIVE SUMMARY

* Failure to meet the reporting requirements can trigger significant civil and/or criminal penalties.

* A tax adviser should ask a client about his home-country tax status and examine the relevant treaty to determine residency status.

* An individual's resident status continues until rescinded or administratively or judicially deemed abandoned.

When a nonresident alien becomes a resident alien (RA) for U.S. tax purposes, he is taxed on worldwide income and subject to estate and gift taxes. This article examines the Code's residency tests and how tax treaties may alter these rules. Recent RAs may have significant reporting requirements because of ownership or directorship in a foreign corporation or a relationship with a foreign trust. In addition, significant tax issues may arise if the individual returns to nonresident alien status.

A number of excellent articles have been published advising tax practitioners about pre-immigration planning for nonresident aliens (NRAs).(1) These articles propose that planning be completed before immigration to maximize opportunities and minimize taxes. In this mobile age, many foreign individuals may inadvertently become U.S. resident aliens (RAs) without the benefit of such planning or perceiving the need for it. Tax advisers understand that when an NRA becomes a resident for U.S. tax purposes, he is taxed on worldwide income and subject to estate and gift taxes. Less well known is how an NRA becomes an RA for U.S. tax purposes, which may differ from becoming a legal RA, and other issues that may arise (e.g., reporting requirements). In addition, significant tax issues may exist if an individual returns to NRA status.

What is an "RA"?

Sec. 7701(b) defines RA and NRA. Under Sec. 7701(b)(1)(A), an alien individual will be treated as an RA if he meets one of three requirements--the green-card test, the substantial-presence test or the first-year election test. As is discussed below, tax treaties may override the Code's prescribed tests; thus, an individual may comply with the Code's residency requirements, but may nonetheless be deemed an NRA under an income tax treaty.

Green-card Test

Sec. 7701(b)(1)(A)(i) provides that an RA is a person who is a lawfully permanent RA at any time during the calendar year. Sec. 7701(b)(1)(A)(i) defines a "lawful permanent resident," as an individual who has been lawfully granted the privilege of residing permanently in the U.S. as an immigrant under immigration laws (i.e., a green-card holder). This residency status continues unless it is rescinded or administratively or judicially ruled abandoned. For the first year of residency, if the individual does not meet the substantial-presence test discussed below, the residency starting date under Sec. 7701(b)(2)(A) is the first day in the year he was present in the U.S. while a lawful permanent resident.

Substantial-presence Test

An individual satisfies the substantial-presence test for any calendar year if he has been present in the U.S. for at least 183 days during a three-calendar-year period and 31 days during the current calendar year. Under Sec. 7701(b)(3)(A), the 183 days is determined based on the sum of the days present in the current year, plus 1/3 of the days present in the first preceding year plus 1/6 of the days present in the second preceding year. An exception applies under Sec. 7701(b)(3)(B) if an individual is present in the U.S. fewer than 183 days during the current year and has a tax home in a foreign country and a closer connection to that country than to the U.S.; according to Sec. 7701(b)(3)(C), the exception does not apply if the individual has applied (or taken other steps to apply) for permanent-resident status. Under Sec. 7701(b)(3)(D) , days in the above formula do not count if the individual has a medical condition that arose while in the U.S. that prevents his departure.

Example: N, a citizen and resident of Country Q, which does not have an income tax treaty with the U.S., travels frequently to the U.S. on business. In 2001, N was present in the U.S. for 144 days, in 2000 for 90 days, and in 1999 for 72 days. N could be deemed an RA for tax purposes under the substantial-presence test, as follows: 144 + (1/3 x 90) + (1/6 x 72) = 186 days, as long as N does not maintain a tax home in Q during 2001. N meets the substantial-presence test, because he has been present in the U.S. on at least 183 days during a three-calendar-year period (1999-2001) and 31 days during 2001. If N continues to have a tax home in Q and a closer connection to that country than to the U.S., he will not be deemed an RA for tax purposes in 2001.

Under the substantial-presence test, an individual is deemed a resident on the first day during the calendar year on which he is present in the U.S. (Certain nominal presence is disregarded.) Under Sec. 7701(b)(2)(C), an individual is not treated as present in the U.S. (up to a maximum of 10 days) for which he establishes a closer connection to a foreign country than to the U.S.

According to Sec. 7701(b)(5)(A), certain individuals are exempt from the substantial-presence test, such as foreign-government-related individuals, teachers and trainees, students and professional athletes temporarily in the U.S. to compete in a charitable sports event. A foreign-government-related individual includes any individual (and his family) temporarily present in the U.S. on diplomatic status or a visa determined to represent full-time diplomatic or counselor status and a full-time employee (and his family) of an international organization. A teacher or trainee is an individual temporarily present in the U.S. under the Immigration and Nationality Act (Act), Section 101(15)(J) or (Q), and who substantially complies with the requirements. Under Sec. 7701(b)(5), a student is an individual temporarily present in the U.S. under Act Section 101(15)(J), (Q), (F) or (M) and who substantially complies with the requirements.

Commuting days spent by regular commuters from Canada or Mexico are not days present in the U.S. Also, a person traveling between two foreign points is not present in the U.S. if there for less than 24 hours. Under Sec. 7701(b)(7), days present in the U.S. by a regular crew member on an international carrier are not counted as U.S. presence unless the individual engages in any trade or business in the U.S. on those days.

First-year Election Test

An individual may elect to be treated as an RA under certain conditions. First, he must not be a green-card holder for the current, immediately preceding or immediately following year. Second, he must be present in the U.S. for at least 31 days during the election year and for at least 75% of the days in a testing period, which begins on the first day of the 31-day period and ends on the last day of the election year. In applying the 75% test, an individual is treated as present in the U.S. for up to five days during which he was actually absent from the country. Sec. 7701(b)(4) provides that, once an individual makes the election, he will be treated as an RA for the portion of the election year...

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