Accidental Americans

Even non-US citizens who don’t want to be subject to the US tax system can sometimes be pulled into it. This is largely due to the fact that, based on a mathematical test, being in the US for more days than the US tax system deems appropriate can make that person a US “resident” for income tax purposes. This can even occur when the non-US citizen did nothing wrong from an immigration perspective and was only in the US as a tourist. The culprit is the so called “Substantial Presence Test.”

In many countries, being present in that country for at least 183 days during the year makes you a tax resident there. That’s true in the US too, but with a catch. If a person has been in the country for at least 31 days in the current year, then a special calculation applies to figure out whether they are deemed to meet the 183 day threshold. The calculation (called the Substantial Presence Test), includes each day present in the US during the current year, one third of the days present in the first preceding year, and one sixth of the days present in the second preceding year. If the sum of those amounts is 183 or more, then the person “fails” the Substantial Presence Test and is deemed to be a US resident for income tax purposes. Mathematically, if a non-US citizen is in the US for 122 days for three consecutive years, that person would fail the test.

A typical non-US citizen tourist (on a B2 Visa) is allowed to be in the US for 183 days. So, someone coming to the US for the winter or summer for four months or so each year for three years, though they would not be violating their immigration or Visa status, could unwittingly become a US income tax resident under the Substantial Presence Test.

US income tax residents are required to file a tax return in the US, pay tax here on their worldwide income, be subject to penalizing anti-deferral rules relating to foreign trusts and interests in foreign corporations and mutual funds, and are subject to US information reporting requirements with respect to their foreign investment interests. Failure to comply exposes them to penalties (some as high as $100,000 or more per infraction) and interest, plus the underlying tax. Needless to say, for a tourist in the US this can come as a shock.

When a person fails the Substantial Presence Test, there are ways out of the situation. First, if they have a tax residence in another country, they may be able to claim a “closer connection” to that country by timely filing an IRS Form 8840 for the year they failed the test. Second, if their resident country has an income tax treaty with the US, then the treaty may provide relief from taxation in the US, but that must be claimed on a timely file tax return in the US that includes and IRS From 8833. In either case, they may still be required to file a Foreign Bank Account Report (or FBAR) in the US to report their interests in foreign bank accounts if those accounts had an aggregate balance at anytime during the year of more than $10,000.

Becoming a US resident or citizen for immigration purposes can be difficult. But, for income tax purposes, it is fairly easy and not always pleasant. Anyone travelling to the US regularly should (1) count the days they are present in the US, (2) timely file for closer connection or treaty relief if they fail the Substantial Presence Test, and (3) remember to file FBARs if needed. If they failed the Substantial Presence Test and didn’t file the right returns and reports, then they should consult with a US tax professional who knows these issues in order to become compliant with the IRS. Careful planning up front, as in most cases, can save a lot of pain in the future.

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