- U.S. citizens and resident aliens are taxed on their worldwide income
- Non-resident aliens are only taxed on their U.S. source income
This may present opportunities to structure your financial affairs before being subject to the full U.S. tax system.
How U.S. Tax Residency is Determined
From the standpoint of the U.S., you are either a U.S. citizen or an alien. If you are not a U.S. citizen, you are considered a resident alien or a non-resident alien. Aliens may be considered resident aliens under the following conditions:
- Green Card Holder – lawful permanent resident
- Substantial presence test
- Elections to be treated as a U.S. tax resident
An income tax treaty can override U.S. tax residency.
Each of these categories of U.S. tax residents are discussed below in addition to general U.S. state tax residency rules and U.S. estate and gift tax residency rules.
If you are a U.S. citizen, you are taxed on your worldwide income, no matter where in the world you may reside, and no matter where your income may be derived. Generally, you are a citizen of the U.S. if you were born in the U.S. or born to a U.S. citizen parent who lived in the U.S. for a certain number of years after age 14. This can sometimes create issues for Canadians born in the U.S. or to U.S. parents; these people may be accidental Americans.
U.S. citizenship can be renounced, but this can create issues if you have a high net worth or income, or have later plans to work in / travel to the U.S.
Green Card Holders
The U.S. Citizenship and Immigration Services (USCIS) may issue a (lawful) permanent resident card (LPR) allowing you to reside and work permanently in the U.S. as an immigrant. You would then be referred to as a Green Card holder or LPR. The tax treatment of Green Card holders is like that of U.S. citizens: you’re taxed on worldwide income no matter where you may reside or earn that income. However, your Green Card may be revoked if you abandon the intention to reside permanently in the U.S.
A Green Card may also be surrendered/abandoned. In the case where a Green Card has expired but has not been formally revoked by USCIS (via the filing of an I-407 Record of Abandonment of Lawful Permanent Resident Status) or surrendered by the holder, you are still subject to U.S. worldwide taxation and reporting.
If you are a non-resident alien receiving a Green Card during the year, you should determine the start date of your U.S. tax residency (e.g., the day from which you become subject to worldwide reporting in the U.S.) If you do not meet the substantial presence test, your first day of tax residency in the U.S. is the day you are issued your Green Card. If you do meet the substantial presence test, you first day of tax residency in the U.S. is the earlier of:
- The first day of presence during the year under the substantial presence test, or
- The day you are issued your Green Card
Substantial Presence Test
The substantial presence test may deem a non-resident alien to be a resident alien based on the number of days they have resided in the U.S. To qualify under the substantial presence test, you must be present in the U.S. for a least:
- 31 days during the current tax year; and
- 183 days over the current year and preceding two years, calculated as follows:
- All of the current year days spent in the U.S.; plus
- 1/3 of the days spent in the U.S. in the first preceding tax year; plus
- 1/6 of the days spent in the U.S. in the second preceding tax year
You are considered to be present in the U.S. on any day in which you are physically present in the U.S. at any time during the day, except:
- Days where you commuted to work in the U.S. from a residence in Canada or Mexico and back again, if you regularly commute to work from outside the U.S.
- Days where you are present in the U.S. for less than 24 hours and where you are in transit between two locations outside of the U.S.
- Days you are unable to leave the U.S. due to a medical condition that develops while in the U.S.
If you meet the substantial presence test, you can still be treated as a non-resident alien because of a closer connection to a foreign country. This closer connection is met if you:
- Are present in the U.S. for less than 183 days during the current tax year;
- Maintain a tax home in a foreign country during the current tax year;
- Have stronger residential ties to the foreign country in which you have a tax home; and
- File Form 8840 Closer Connection Exception Statement for Aliens with your U.S. return for the tax year
It is important to note that if you are physically present in the U.S. for 183 days in the current year, you may not claim closer connection to another country and are a U.S. tax resident. Also, if you have made an application for a change in status to Lawful Permanent Resident (Green Card holder) and are substantially present in the U.S., you are a U.S. tax resident under Regulations 7701(b)(3)(B) and (C). There may be relief from U.S. taxation through operation of the tax treaties in both these situations, but a U.S. tax return disclosing, but not taxing, worldwide income and full foreign information reporting would still be required. Careful planning around timing of the application for a Green Card is required.
If you are a non-resident alien qualifying under the substantial presence test during the year, you should determine the start date of your U.S. residency (e.g., the day from which you become subject to worldwide reporting in the U.S.) Under the substantial presence test, the first day of residency in the U.S. is the first day of presence in the U.S. However, you may exclude up to the first 10 days of presence in the U.S. for the purpose of determining the first day of residency if:
- Those 10 days are non-consecutive;
- You are a resident of another country during the excluded period; and
- You have a tax home in another country during the excluded period
As an example, let’s meet Cassie. Cassie was born and raised in Canada and came to the U.S. for a work assignment in 2021. Her parents are not U.S. citizens. She was in the U.S. for 142 days in 2021. She was in the U.S. for 99 days in 2020 and 42 days in 2019.
Cassie does not meet the substantial presence test in 2021 based on the calculation below. We could possibly file Form 8840 Closer Connection Exception Statement for Aliens for Cassie for 2021, as she was in the U.S. for less than 183 days in the current year, and presuming that she had a closer connection to her home country.
|Days Present in U.S.
|SPT Inclusion Ratio
|Days Counted for SPT
Elections to be Treated as a U.S. Tax Resident
There are a few different elections available if you wish to be treated as a U.S. tax resident. These are summarized as follows:
- First-Year Election 7701(b)(4)
- If you will meet the substantial presence test in the next tax year, you may elect to be treated as a part-year (dual-status) resident of the U.S. in the current year, as long as you were present in the U.S. for at least 31 consecutive days in the current year, and in the U.S. for at least 75 percent of the time beginning with the first 31 consecutive days in the current year and ending December 31st of the current year.
- May be able to claim additional exemptions for spouse and dependents
- Can claim post-arrival foreign deductions and foreign taxes which would not ordinarily be available
- Post-arrival worldwide income is now subject to U.S. taxation, however a foreign tax credit may mitigate the increased U.S. tax
- Full-Year Elections 6013(g) and (h)
- Spouses who are not both full year residents may elect to be taxed as full year residents, under certain conditions
- This enables you to file joint returns (which can only be filed by full year residents)
- Can use married, filing jointly tax rates and tax brackets
- Can claim post-arrival foreign deductions and foreign taxes which would not ordinarily be available
- Entire year’s worldwide income is now subject to U.S. taxation, however a foreign tax credit may mitigate increased U.S. tax
- Please note that filing a Married Filing Joint U.S. tax return is a silent election to have both spouses treated as U.S. resident taxpayers for the full year. This election cannot be easily revoked after the filing deadline.
Income Tax Treaty
At the time of this writing, the U.S. has a tax treaty in force with 66 countries. If you are arriving from one of these countries to the U.S., it is likely that the residency article of the respective tax treaty will help determine your U.S. tax residence status. As an example, Article IV of the U.S.-Canada Tax Treaty states:
- Paragraph 1 – A “resident of a Contracting State” is defined to mean a person who, under the laws of that State, is liable to tax by virtue of their domicile, residence, citizenship, or other criterion. This basically outlines that tax residency is first determined under each country’s tax rules.
- Paragraph 2 – By virtue of paragraph 1, an individual may be a resident of two Contracting States at the same time – a dual resident. When this occurs, the U.S.-Canada Tax Treaty provides tie-breaker rules for determining the country in which you are a tax resident. The tax residency tie-breaker rules look at the following, in order:
- The country where you have a permanent home available to you
- The country where your centre of vital interests is strongest. Your centre of vital interests is defined as your personal and economic ties, such as the location of your family and social relations; your occupations; your political, cultural, or other activities; your place of business; the place from which you administer your property; etc.
- The country in which you spend the greatest amount of time (habitual abode)
- The country of your citizenship (note that a U.S. Green Card holder is not a U.S. citizen)
- Competent authorities of both countries will settle the question of your tax residency by mutual agreement if the above sequence of tests is not conclusive
U.S. State Tax Residency
Generally, each state has its own tax residency tests, which typically differ from the U.S. federal concepts. Many states use a domicile test, which considers you a tax resident of that state, even if you were outside of that state for a temporary period. Domicile is the place where you have your permanent home and where you intend to return if you are living or working temporarily in another state. Your domicile is a question of fact.
Many states also have deemed domicile tests. As an example:
- Arizona deems you to be a tax resident if you spend more than nine months of the tax year in the state
- New York deems you to be a tax resident if you maintained a permanent place of abode in the state, and, spent more than 184 days in the state during the tax year
Note that you can be a U.S. state tax resident, but not a U.S. federal tax resident. Likewise, you can also be a U.S. federal tax resident, but not resident in any state.
U.S. Estate and Gift Tax Residency
U.S. estate and gift tax has a different concept of residency than income tax. You are subject to U.S. estate and gift tax if you are:
- A U.S. citizen, or
- Domiciled in the U.S. (see above for definition of domicile)
If after departing and terminating U.S. tax residency in one calendar tax year, a non-resident alien returns to the U.S. and resumes U.S. tax residency at any time during the subsequent calendar tax year, the alien will be classified as a resident alien for the entire continuous period. This can lead to unintended U.S. tax implications, and thus should be closely monitored.
As you likely gathered from this article, U.S. tax residency is complicated! It is best to review your unique situation with a qualified cross-border tax planning advisor and financial planner as soon as you begin spending more than a couple of months a year in the U.S., and well ahead of your actual move date to the U.S. There may be opportunities to structure your financial affairs before being subject to the full U.S. tax and reporting system. For more information, please contact Cardinal Point.