Spending time traveling can be a fulfilling experience. Living abroad, you’ve likely spent time with extended family and learned a lot along the way. Perhaps work has you traveling cross borders or maybe it’s family. Whatever the case, understanding residency status for tax purposes is vital for your finances. Let’s say you are not a U.S. citizen or lawful permanent resident nor have you been classified as one in the past, but you still work or travel in the States quite often. Are you then responsible for paying taxes in the U.S.? To determine the answer, the IRS uses two tests. If you pass either one of them, you are a considered a resident in the U.S. for Tax purposes.
The Substantial Presence Test
The Substantial Presence test signifies whether an individual is considered a U.S. resident for tax purposes – whether they have to pay taxes to the IRS. To meet this test, you will have to have been in the U.S. for at least 31 days in the calendar year and meet the 183-day rule. An individual abides by the 183-day rule if they have been in the U.S. for 31 days of the calendar year and 183 “days” in total over the last 3 years. The reason why “days” is in quotations upcoming. The IRS counts days in the 183-day test as any number of days present in the U.S. in the calendar year, 1/3rd of the days you were present in the year before the current calendar year and 1/6th of the days you were present in the year two years before the calendar year. Sound complicated? That’s because it is.
Let’s take a look at an example of the 183- day rule. Johannes has been in the U.S. 150 days of this year, 30 days the year before and 36 days two years before. The 150 days from this year are counted, 10 days are counted from the last year (1/3rd of 30 days), and 6 days are counted from the year two years prior (1/6th of 36 days). In total, Johannes meets 166 days of the 183 required to be considered a resident for tax purposes so he does not pass the substantial presence test.
Imagine a situation where you are close to meeting the requirements of the test but aren’t entirely sure. What counts as physical presence in the United States? Well here is what doesn’t count: Any days you commute to work from your residence outside the country, days you are in the U.S. for less than 24 hours when you are in transit, days you are in the U.S. as a crew member of a foreign vessel, days you are unable to leave the U.S. due to a medical condition that develops in the U.S, and days you are in the U.S. as an exempt individual (definition below).
Exempt individuals are those who are present in the U.S. under certain visas. Here is the list of exemptions: Individuals in the U.S. under an A or G visa (but not an A-3 or G-5), a teacher or trainee in the U.S. under a J or Q visa, a student in the U.S. under a F, J, M, or Q visa, or a professional athlete present in the U.S. to compete in a charitable sports event.
As you can see, there are many fine details involved with the Substantial Presence Test, so keep comprehensive travel logs readily available for your financial advisor.
The Green Card Test
The Green Card test is much simpler than the Substantial Presence Test however it is still important because passing either test results in residency for Tax Purposes. An individual meets the Green Card test when they have spent at least one day in the U.S. as a lawful permanent resident (ie: held a green card). Individuals are not required to hold a green card when they file their tax return. The only exception to the GCT is if a citizen voluntarily renounces his resident status, the USCIS administratively terminates the residence’s immigrant status, or a federal judge judicially terminates the resident status.
While one test is much simpler than the other, passing one (or both) of the tests result in residency classification in the U.S. for tax purposes. At which point, your financial advisor will inform you of best practices.