Pre-Immigration Planning: Understanding U.S. Income Tax Residency Status by Pedro L. Porras, CPA
Posted on October 13, 2022
Immigrations laws in the U.S. differ from the country’s tax laws, which require individuals to report and pay federal income tax based upon the government’s classification of their residency status. While it is not uncommon for someone to live in the U.S. without establishing residency for tax purposes, it is important to recognize when this changes and how adequate advance planning can go a long way toward ensuring tax efficiency and avoiding costly mistakes down the road.
In the most basic terms, the U.S. presumes foreign citizens to be nonresident aliens (NRAs) for tax purposes until they file for a green card, meet a substantial presence test or make a special first-year election. Once any of these conditions are met, immigrants coming to America are considered resident aliens (RAs) subject to U.S. taxes on their worldwide income and not just those assets located in the states. Yet, it is important to note that the U.S. tax code is far from basic; not only is it quite complex, but it also includes a broad range of ever-changing exceptions and exclusions to the rules for which immigrants must remain mindful and plan accordingly.
Green Card Test
Foreign citizens granted green cards from the U.S. Citizenship and Immigration Services (CIS) are considered U.S. residents for tax purposes regardless of how much time they spend or have been present in the country. When immigrants receive green card in the middle of a calendar year, they may be considered dual-status citizens subject to U.S. taxes only during the portion of the year after they earn U.S. tax residency. Should individuals voluntarily surrender their green cards, they may be subject to a U.S. Expatriation Tax, for which all their property is considered to have been sold for fair market value and therefore subject to capital gains taxes in the current tax year.
Substantial Presence Test
The substantial presence test of U.S. tax residency relies on a three-year weighted formula that considers the actual number of days an individual is physically present in the U.S. More specifically, nonresident aliens will pass this test when they are present in the U.S. for 183 days in the current year, or a minimum of 31 days during the current tax year plus 183 days over a three-year period. This includes the days they are in the country during the current tax year, one-third of the days in the prior year and one-sixth of the days in the year before that. Special care should be taken to recognize that days traveling into and out of the U.S. are usually considered full days when computing the substantial presence formula.
Although a person’s U.S. tax residency typically begins on the first day that he or she is present in the U.S., there are exceptions for the days the individual commuted to the U.S. from a residence in Canada or Mexico, the days he or she was unable to leave the U.S. due to a medical reason that occurred while in the country or the days spent in transit between foreign countries. Additional exceptions to the substantial presence test exist for certain students, teachers, officials from foreign governments and individuals with “closer connections” to another foreign country where they maintain “tax homes” during the calendar year. Further analysis is often required to establish the latter exceptions, which are based on vague definitions.
The First Year Choice
Immigrants who do not pass the green card test or who arrive in the U.S. too late to pass the substantial presence test may make a special, first-year election to be treated as a resident alien beginning on their date of arrival, provided they meet the following conditions:
- They are not otherwise considered a resident alien for the year or at any time during the preceding year;
- They are present in the U.S. for a minimum of 31 consecutive days during the year in which the election is made;
- They are present in the U.S. a minimum of 75 percent of the total days beginning at the start of the 31-day period and December 31 of the tax year; and
- They are resident aliens under the substantial presence test for the following year.
With this first-year election, immigrants are considered dual-status aliens who may also make resident alien elections on behalf of their children. As such, they are bound by the tax laws of both the U.S. and their home countries. When tax treaties exist between two countries, competing claims of residency are resolved via tie-breaker provisions that aim to prevent double taxation and any attempts of one country’s residents to avoid paying tax on income they earned within and outside that country.
There is no one-size-fits-all tax rule that applies equally to all U.S. residents. Rather, different tax laws will apply differently to everyone’s unique circumstances. For this reason, foreign citizens should seek the advice of professional legal and accounting counsel to assess their personal circumstances and identify strategies to help improve tax efficiencies both domestically and in other jurisdictions where they hold assets and maintain homes. Pre-immigration planning is the best option to meet this goal, protect one’s assets and avoid the potentially unpleasant consequences of the U.S. tax system.
About the Author: Pedro L. Porras, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where he provides income and estate tax planning and consulting services to domestic and foreign high-net-worth families and closely held businesses with international operations. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or at firstname.lastname@example.org.