As a rule, a foreigner will be considered a resident of the USA for fiscal purposes if they fall under the criteria of the Substantial Presence Test, except in the case of obtaining a green card (permanent residence in the USA), in which case US tax residency is automatically obtained.
To meet the criteria of the substantial presence test, the foreigner must be physically present in the US, fulfilling the following conditions: 31 consecutive days or more during the current year, subject to the calculation of the percentage of the stay in the country, which if it reaches 75% already qualifies you for US tax residency in the first year, and if you stay for 183 days during the 3-year period that includes the current year and the 2 years immediately before that, which is calculated as follows:
- All the days you were present in the current year, and
- 1/3 of the days you were present in the first year before the current year, and
- 1/6 of the days you were present in the second year before the current year.
After obtaining US tax residency through the physical presence test, the foreigner is required to declare their global income in the US, as well as fulfill any ancillary obligations (Tax Return, Foreign Bank Assets Forms – FBAR and Foreign Account Tax Compliance – FATCA, etc).
However, there are some cases in which the foreign individual may be considered exempt from the physical presence test, and may remain in the US territory with nonimmigrant status (without obtaining US tax residency). During this period, the foreigner is required to report to the US government only the income earned within the US territory, with no need to report their global income.
The Internal Revenue Code provides for two exceptions to the substantial presence test that can be used by foreign nationals to maintain non-resident status:
- Closer Connection Exception to the Substantial Presence Test, applicable to any foreign individual; and
- Closer Connection Exception to the Substantial Presence Test for Foreign Students, specifically applicable to foreign students who remain in the US for a period exceeding 5 (five) years.
We will discuss below the main aspects applicable to these two exception hypotheses:
- Closer Connection Exception to the Substantial Presence Test
The Internal Revenue Code (IRS) has an express provision that allows a foreign individual who has passed the US physical presence test (staying in the US for a period exceeding 183 days in the last 3 years) to claim an exception through the procedure, named the Closer Connection Exception to the Substantial Presence Test, provided the following requirements are met:
- Physical stay in the US for a period of less than 183 days during the current year;
- Proof of a closer connection (closer connection) with a foreign country in which the foreigner has tax residence for the current year.
In this context, the foreigner may be treated as a non-US tax resident if he physically remains in the US for a period of less than 183 days during the current year and if he proves the existence of a closer connection with a foreign country in which he has tax residence.
In order to determine whether the alien has had more significant contacts with another country than with the US, the facts and circumstances to be considered include, but are not limited to, the following:
1.1 Proof of the country of residence designated by the foreigner, on forms and documents;
1.2 The location of: your permanent home; your family; your personal belongings such as cars, furniture, clothing and jewelry; your current social, political, cultural or religious affiliations; business activities (other than those that constitute your tax home); the jurisdiction in which the alien holds a driver’s license; the jurisdiction in which the foreigner votes; and charitable organizations to which the foreigner contributes;
1.3 Description of the tax residence in the same foreign country to which you claim to have a closer connection throughout the tax year.
To claim the closest connection exception, the alien must file Form 8840 – Closer Connection Exception Statement for Aliens.
However, the foreigner cannot claim to have a closer connection with another country, if he took steps during the year to change his status to that of a permanent resident (green card).
If the alien has filed any of the forms listed below, this may describe his or her intention to become a lawful permanent resident of the US, disqualifying him for the closest connection exception.
Form I-508, Waiver of Rights, Privileges, Exemptions and Immunities; Form I-485, Application to Register Permanent Residence or Adjust Status; Form I-130, Petition for Alien Relative; Form I-140, Immigrant Petition for Alien Worker; Form ETA-750, Application for Alien Employment Certification; Form OF-230, Application for Immigrant Visa and Alien Registration.
2. Closer Connection Exception applied to international students:
The physical presence test does not apply to the foreign student holding an F-1/F-2 visa for a period of 5 years, provided an exemption is required through form 8843.
During this period, the student can remain in the US territory with nonimmigrant status, without obtaining tax residency. However, if they earn income within the US, they will be required to report it to the US government.
After the 5-year exemption period, it is possible for the student to remain in the US for a period exceeding 183 days during the current year, provided that he/she proves the closest connection with a foreign country, meeting the requirements listed below, through form 8843 in attached with forms 1040-NR or 1040NR-EZ:
⁃ Do not intend to reside permanently in the US;
⁃ Comply with all necessary requirements for nonimmigrant status that apply to students;
⁃ You have not taken any action to change your status from non-immigrant in the US to becoming a legal permanent resident;
⁃ Declare and prove closer connection with a foreign country, than with the USA, in accordance with the items mentioned above; (1.1 to 1.3).
”Finally, it is worth highlighting the importance of monitoring the length of stay in the United States, evaluating the possible alternatives provided for by the law, in order to avoid the characterization of the tax residence in an unplanned manner, as the status of a US tax resident, generates for the taxpayer the obligation to declare global income in the USA, without there being alternative tax savings. Every change, especially when it involves another country, requires analysis and planning for decision making’’.
Written by Thailane Izabel, Tax Consultant at Drummond advisors